America’s business community has always liked the color “green.” Traditionally, it was about earning U.S. dollars. Today, it’s about brandishing a woke environmental image.
Perhaps nothing showcases this better than the trend toward “Environmental, Social and Governance” (ESG) investments by those on Wall Street. Particularly attractive to millennials, the pitch for investing in ESG’s is to not just “make money,” but “make the world a better place” while doing it.
A noble-sounding idea? Perhaps. But as Rupert Darwall points out in a newly released study “Capitalism, Socialism and ESG,” there’s more to this racket than meets the eye.
That notion of a “better” world from ESG investments applies only if you agree with progressive climate and social agendas. For those who identify as anything other than “liberal,” backing investment strategies to kill fracking jobs, attack red meat, and help promote a Green New Deal economy may prove a bit hard to swallow.
What about all that money to be made? Turns out it is less for your portfolio and more for the bottom line of Wall Street companies.
For example, BlackRock charges 46 cents annually for every $100 invested in its iShares Global Clean Energy ETF, while it charges just 4 cents for iShares linked to the S&P 500 in comparison.
It pays to be woke – if you’re a Wall Street fat cat, that is.
As for average Joe investors buying into these ESG stocks, their bottom lines aren’t as lucky.
Darwall explains that while in the short-term it seems like ESG-favored stocks outperform their competitors, in the long run, they underperform.
Why? ESG conflicts with the main tenets of finance theory. Darwall explains:
‘(D)uring the adjustment period the highly rated ESG stocks will outperform the low ESG stocks, but that is a one-time adjustment effect. Once prices reach equilibrium, the value of high ESG stocks will be greater and the expected returns they offer will be less. In equilibrium, highly rated ESG stocks will have greater values, but investors will have to be satisfied with lower expected returns.’
A recent study by Scientific Beta seems to concur with this assessment. The authors of the Scientific Beta report found that ESG investment strategies do not really outperform traditional ones, especially when “quality” metrics are factored in.
So damning was this report that in an interview with the Financial Times, Sony Kapoor, managing director of the Nordic Institute for Finance, Technology and Sustainability, quipped it “puts in black and white what is only whispered in the corridors of finance—most ESG investing is a ruse to launder reputations, maximize fees and assuage guilt.”
As if this wasn’t bad enough, the flawed concept of ESG investing doesn’t stop there.
Darwall explains that the standards that rate a company “sustainable” or “environmentally-friendly” are quite subjective.
Take Tesla, for example. At first blush, one would think a company that manufacturers electric vehicles would score highly using ESG criterion. But not so fast. As Darwall notes: “Tesla has been rated best, worst, and middling by three different ESG raters (MSCI, CLSA, and Sustainalytics, respectively) for global auto ESG at the same point in time.”
Why the disparity? Because different funds evidently use different standards.
Perhaps James Mackintosh of the Wall Street Journal best amplifies Darwall’s point by comparing Tesla with fossil fuel giant Royal Dutch Shell. According to Mackintosh, although Tesla makes EV’s, which is a plus, it also manufactures cars that are “big and heavy, and often powered by electricity produced by burning coal, while its labor relations are poor and it is run by a billionaire who has little regard for the rules….” Shell Oil, in contrast, might produce fossil fuels, but it has laid out plans to go carbon neutral by 2050 and has a “gender-balanced” company boardroom.
Bottom line: Both Tesla and Shell get a roughly equal ESG score.
There are many other alarming issues with ESG investing contained in Darwall’s “Capitalism, Socialism and ESG” report. These include things like letting bureaucrats potentially toy with state retiree pensions to achieve ESG political ends and allowing corporate oligarchs like Michael Bloomberg to craft a “disclosure regime that better enables investors to assess risk.”
Regardless of the obvious issues, ESG is likely to remain a powerful force on Wall Street for the foreseeable future. This is because the movement has some big backers. Political leaders like Al Gore, billionaires like Michael Bloomberg, and more than 180 CEOs signed the Business Roundtable on business purpose supporting ESG goals. In the U.S., The Wall Street Journal reports that ESG portfolios have already raked in a hefty $14.8 billion in new money in the first quarter of 2021.
With all that green, ESG is clearly off and running. The real question is, will it prove itself “sustainable” over the long run?
Craig Rucker is president of CFACT.