Whither ESG Next?


“Inability is often the mother of restriction, and restriction is the great mother of inventive performance.”—Holger Czukay

A sadly deceased German musician is an unlikely source of investment advice. What’s more, viewing inability and restriction as positives goes against our usual preference for choice and options. Environmental, Social and Governance (ESG) investing has created an industry full of data providers, publishing lists and rankings of the world’s best-known firms and their credentials. Among many things, these lists attempt to capture treatment of the environment, community engagement and ethics. However well-meaning these organizations may be, the guiding principle of shareholder primacy remains largely unquestioned. Nominal adoption of ESG principles, in theory or practice, has not yet superseded the requirement for returns. Recent allegations of greenwashing at large banks and investment firms have raised an uncomfortable proposition: that, even with a flood of data and expertise to point the way to a greener future, there remains little consensus regarding what ESG principles are or how to know which managers and products adhere to them.

Despite its popularity, sustainable—with an emphatically small ‘s’—investing is an alternative, niche area, looking for specialized investors that are not passive, can absorb risk, think long-term and perhaps finance and support ideas that only become businesses later. Although the market capitalization available to investors in sustainable companies is limited, this need not mean that ESG principles must take a back seat as less important investment objectives. Rather, managers have a chance to truly differentiate themselves and take a stand for or against chosen social issues.

For those unfamiliar with ESG rankings, JUST Capital is one of the leading firms to measure corporate performance against social issues. As a ranked who’s who of US ESG companies, the JUST 100 reads like an S&P all-star team, with tried-and-true blue chips dominating. But if all the biggest companies are virtuous, doesn’t that virtue become dubious or at least lose value? The effort to concentrate even more wealth and investment in the largest companies under the guise of ESG principles allows these firms to infer that they are the best arbiters of them (alongside the data providers that report on their adherence to these principles). The investor, entrusting their money to a third party, is then allowed to forgive the more unsavory aspects of relentless profit-seeking based on an expert’s advice of how well it has been mitigated.

Do we forgive ghoulish government lobbying spend, mass layoffs, union busting, the use of taxpayer subsidies for share buybacks or investment in for-profit prisons because of the occasional charity gift, Pride flag banners or hiring of diverse executives?  ESG investing may not be as complex an exercise as ESG data providers think.

Maybe the litmus-test focus of some 90s investors could lend ESG product developers a hand, with their Ex-Tobacco and Ex-Natural Resources funds. Ex-Explicit Music was even championed by the now defunct Parents Music Resource Group who was busy labelling music as “explicit,” making it easy for like-minded investors to apply a ban on shares of entertainment conglomerates whose subsidiaries released it. Taste aside, the message was clear: we know it makes money, we just don’t think it’s a nice way to make it.

A few ideas more suited to today’s environment include:

  • Ex-Eminence Grise: does not include any firm that is a known Washington lobbying spender, including members or affiliates of listed industry lobbying groups.
  • Ex-Misery Merchant: does not include any defense contractor, manufacturer of firearms or firm involved in incarceration and detainment.
  • Ex-Subsidized Returns: does not include any company that in the past five years has both 1) received a subsidy of any type from the US government and 2) bought back shares or paid dividends.
  • Ex-Union Buster: does not include any firm that is actively seeking to discourage worker unionization. Also, any firm currently in dispute with the National Labor Relations Board or in litigation with existing labor unions.
  • Ex-Obesity: does not include manufacturers of snack foods or soft drinks with high levels of refined sugar.

Firms precluded from investment by the above criteria share some key characteristics. They are massive. They are listed. Their reach is global. Their annual reports are pored over by hundreds of research analysts. Their ESG credentials are trumpeted by industry experts, often loudly. Eliminating their stocks from a portfolio would leave the investor looking hard for a suitable benchmark. But most importantly, the investor has a clear vision what types of business s/he will not invest in, as well as what should be allowed to generate returns.

Furthermore, there is far less subjectivity regarding constituents’ inclusion in the portfolio. Though the data required to determine their inclusion may be less structured or accessible, it does not require complex scoring or ranking, nor does it emphasize relative comparisons over more absolute objectives. Perhaps as Mr. Czukay implies, the restrictions can open the doors to the reinvention of what “investment” actually means, beyond established industries, markets and benchmarks.

Where then, are the investors who see these principles as too important to trust others with, be they company executives, benchmark providers or ESG data sources? They are probably rather lonely, seeking out small firms and localized ventures, speaking to institutions, communities and stakeholders outside the boardroom, most likely by themselves. No one has ever tweeted about their celebrity relatives or wardrobe choices. Their products remain on the fringes, resembling hedge funds in their infrequent valuations and high-risk asset mixes. They combine public and private investments, real-time exchange transactions with extended pipeline management, and don’t have much to which they can compare themselves. It is possible that their products haven’t even been launched yet, as the research and scrutiny involved simply requires time and patience. It’s a quiet and humble place, but one where innovation, originality and transformative change all thrive.