About twenty years ago, I had the opportunity to be involved with a socially responsible investment (SRI) firm.
At the time it seemed to be a very small niche market, but in my childhood years I had yearned to be a marine biologist, and so investing with a mind toward the environment and having an overall positive impact tugged at the heart strings.
It was a time when the phraseology was morphing from SRI to ESG. To be socially responsible leaned toward socialism, which could perhaps dissuade potential adherents. Environmental, social and governance projected a stronger message, and so the rebranding push was on. It’s not really clear to me where the rebranding push originated. This was also the time when Al Gore was promoting his “Inconvenient Truth” film, so it could have been his idea. Nonetheless, ESG became the new thing.
In dissecting the investment firm’s Canadian equity portfolio I came to realize that it mirrored the Toronto index quite closely. I found that to be curious given the heavy index weighting in oil and gas and mining, among other very un-ESG holdings. I also noticed that the portfolio’s performance struggled. It was an inspiring cover to a lacklustre book.
I queried the holdings and the apparent inconsistency and was told that the firm’s objective was to mirror the Toronto index. This meant they had to select the most progressive companies represented in each of the sectors of the index. I nodded my head – that sounded reasonable. In retrospect the response seemed defensive and well-rehearsed, almost a mantra. It struck me as strange, and maybe I had struck a nerve. Successful investment firms have a clear discipline that stands up to scrutiny; this needed some work.
But some investors were early devotees to the SRI and ESG concepts and were willing to sacrifice some performance to feel like they were making a difference in the world around them. Since the theme was still in its early stages, there were many interpretations of what ESG really meant, and investors were very divided in advocating for what they believed it should mean.
Fast forward to today and money is pouring into ESG themed indexes and strategies. Over the past twenty years the ESG brand has tightened up considerably (although arguably still pretty muddy). The big index fund firms built large offerings of ESG solutions, and continue to attract huge sums of investors’ money. The fund flows to ESG are such that we now see many main steam investment firms incorporating ESG in one form or another.
In addition, a host of investment management firms have built strategies specifically focused on buying the beneficiaries of this rush of money (lithium mines, digital payment companies, wind and solar infrastructure, etc.). ESG has gone from being a fringe theme, to being driven by boardroom strategy. Skepticism has turned into a faith.
Publicly traded companies are ranked for their ESG scores, and many of these themes have crept into the culture of the business. While businesses are established to provide products and services at a competitive cost, with the reward being profits and growth to shareholders and owners, that mission has now been altered. Business models must now accommodate specific ESG themes. Profit, while currently still the main driver, is being subsumed by the growing array of divergent environmental, social and governance metrics.
The simplicity of a business is to produce profit. Putting other things in the way, however virtuous, detracts from the objective.
But fundamentally ESG should be a good idea, and it would stand to reason that ESG screens would be beneficial to all. So, what does ESG mean to you and me?
Fundamentally a capitalist environment means that those who work reap the rewards, and those who work harder or smarter reap more of the rewards. If a business is well run and serving its stakeholders, then everyone should win.
ESG elevates the notion of the “stakeholder”. This individual may be remotely affected by the business while not directly involved, but now this person also has a say in how the business should operate. As a hard-working shareholder and investor, my interest is now diluted by someone who likely has a lesser contribution level (if any at all). The playing field has been changed. As a result we begin to see contortions and contradictions creeping into our way of life.
Looking at a specific example, carbon emissions from vehicles have been deemed to be detrimental. Governments are moving to eliminate any gas or diesel powered engines. My family purchased an electric vehicle 3 years ago. We love the performance, it gives off no emissions, and the notion of never stopping at a gas station is very gratifying. But it’s not that simple. The energy to power the vehicle has to come from somewhere. The battery uses lithium which is in limited supply, and mining lithium is a very destructive process. Then there is the construction of the vehicle, which still uses rubber tires, plastic components and a steel structure. It’s not much different from a traditional vehicle, except you may want to think twice about taking it on a long trip.
Recycling is another interesting theme. Coincidentally, I recall the recycling phenomenon starting about 20 years ago, around the same time SRI morphed to ESG. I was initially resistant to recycling – why change what we have been doing forever?! I likely should have dug a little deeper at the time but was convinced of its virtues. Recently, after my weekly routine of sorting our garbage into various bins, I was late in getting the bins out. I spoke with the garbage truck driver, saying that I guess I had missed the recycling truck. He said not to worry, I could put it into his truck – it all goes to the same place anyway. I was dumbstruck. I wandered into the house sharing this morsel of information, still not quite believing what I had been told. What - it all goes to the same place? Yet, I have been conditioned, and like a good citizen, continue to separate my garbage every week.
The oil and gas industry has been the recipient of much of the ESG ire, with many western governments planning to eliminate it over time. Ironically, the emergence of this industry as a fuel source is tied directly to prosperity and life longevity. So, while oil and gas and its consequent emissions take a lot of heat (sorry), the industry has contributed significantly to the robust social structure we now enjoy, and there is no renewable energy source even remotely close to replacing it. As the west limits and constricts oil and gas production, we buy oil from countries with less stringent environmental standards of production, and China brings on two new coal plants per week. This is a failure in logic.
We inherently want what is good for our families, our communities and the environment. We also want businesses to be successful, and that our investments in them should flourish. SRI and ESG started as a grass roots movement by a few motivated investors, but even that struggled because the returns simply were not compelling. There was a catalyst that powered the ESG movement to its current level, and still there is no convincing evidence of its benefits.
During my career, I have learned to A) keep things simple (not always easy), and B) to ask questions (you know you’re getting somewhere when you hit a nerve). The ESG theme presents a strong message with much underlying complexity and contradiction. As investors in our environment, our society and our governance, I believe we would be well served as individuals to ask many more probing questions of this movement.
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