January 11, 2019
Socially responsible investing, perhaps most popularly characterized as “ESG” investing, or “Environmental, Social, Governance” investing has become increasingly popular among younger investors in particular. But should ESG have a place in your portfolio?
Call me a skeptic, but I’m not altogether convinced that investing in companies that engaged in efforts to improve the planet or pursue justice is the best way for us to actually accomplish those things. Perhaps I’m a bit cynical too (though I’ve been told that’s a required trait for us Gen Xers). I recently saw a quote on Twitter that really encapsulated my feelings on this:
“We are living in an era of woke capitalism in which companies pretend to care about social justice to sell products to people who pretend to hate capitalism.” – Dr. Clay Rutledge, Sept. 6, 2018
When I think about this, I wonder why I would want to defer the implementation of my own personal beliefs to the management team of a publicly traded company? It’s reminiscent of the arguments in favor of conglomerates back in the 1960s or even in the early 2000s (I’m thinking of a certain producer of light bulbs, jet engines and derivatives) that somehow investors benefit from diversification. While portfolio diversification is beneficial, unless you can only own one stock, investors can diversify simply by buying stocks in a diverse basket of companies. In the same way, why would I invest in a company that supports a few causes I agree with, instead of just investing in a good company with solid returns and then I can simply use the return on my investment to contribute to those causes and get a tax deduction as a bonus? In fact, it could even be better if I simply donate shares of appreciated stock to the non-profit organizations that work in areas I care about, creating even greater tax benefits beyond the social benefits of my charitable impulses.
Certainly, we can see the importance of the G in the ESG space, as good corporate governance is essential for long-term performance. I often view corporate governance scores from ISS or other providers and I have a nasty habit of reviewing Board committee charters and governance guidelines on companies that interest me. It’s very important to understand how management is compensated, what risks are inherent in that compensation scheme and what controls are in place to mitigate the potential for fraud or malfeasance. As a former auditor, I am firmly committed to the idea of “trust but verify” to prevent me from investing in the next Enron. It also helps to see the sorts of incentives are offered to management and how they might potentially game the system. Having adequate controls and good governance practices are essential to illustrating whether a company might be a good investment.
What about Environmental concerns? While I am not a hard-core environmentalist by any stretch of the imagination, I am more of a conservationist. I don’t believe we should be wasting any resources, whether the natural resources in our environment, or raw materials, heavy equipment, office supplies or food belonging to the company. I also believe that companies should comply with all applicable laws and regulations, whether environmental or otherwise. The question remains whether there is a value to shareholders of spending scarce resources on environmental concerns that may not have a measurable return. It may be valuable to determine where a company is using resources and whether they can be used more efficiently, but this is more in light of effective stewardship of company assets. I am not convinced of the value of measuring abstract concepts like carbon footprint, where the actual measures are subject to debate and the ultimate actions resulting from such measures are subject to even further debate.
The social aspects of ESG are by far the most problematic for investors like me. It’s not that there is anything inherently wrong with social concerns, but there is something inherently personal about them. The best approach companies can take with social concerns is to maintain neutrality, as no matter what side a company takes on a social issue, they are likely to alienate at least half of their customer base. We have seen this play out recently with situations like Dick’s Sporting Goods (Tii:DKS) and Nike (Tii:NKE). These companies are leaders in their industries, but decided to take a stand on a controversial social issue, in Dick’s case it was a change to gun sales and for Nike it was an advertising campaign that highlighted Colin Kaepernick. These were both hot-button issues with extreme levels of disagreement on each side and by taking one side, each company alienated customers on the other side, thus hurting their businesses. Then there are the classic “sin” stocks, companies in the business of alcohol, tobacco, casinos and similar businesses that some segment of the investor population find objectionable. The approach that most investors take is to avoid investing in companies with businesses the investors disagree with, rather than taking a position and advocating for the company to fundamentally change their business.
Overall, ESG related investment managers and portfolios have been growing substantially over the past decade or so, and in a recent article in the Financial Analysts Journal entitled, “Why and How Investors Use ESG Information: Evidence from a Global Survey” authors Amir Amel-Zadeh and George Serafeim note the significant increases in the use of ESG criteria among professional asset managers. As evidence, they point to the fact that as of 2016 the UN Principles for Responsible Investment had about 1,400 signatories, with assets under management (AUM) of about $60 trillion, a significant segment of the investment world. Studies have also shown that companies’ disclosure of ESG data has a relationship to economically beneficial effects, such as a lower cost of capital. While this may seem to make sense, is it quantifiable, particularly given that ESG measures themselves are not consistently quantified across industries and markets. Until we have consistent and broadly accepted definitions of what constitutes best practices across ESG measures, it seems like quantifiably proving the economic benefit of ESG will still be a stretch.
Ultimately I tend to come down on the side of responsible stewardship when it comes to expending company resources on these efforts. In areas where there is a clear benefit to shareholders, pursuing ESG initiatives are a responsible action. For more questionable social areas, I am reminded of some of the more apocryphal stories from the late Wade Thompson, co-founder of RV giant Thor Industries (Tii:THO). When asked at one time whether the company could donate some resources to a worthy charitable cause, Wade responded that the money was not his but rather it belonged to the shareholders. He had no problem if the managers or employees wanted to donate their own time and money to a cause, but he drew the line at donating money or resources that rightfully belonged to shareholders.
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