By pressuring companies to put “sustainability” for profit, they harm retirees, small investors, and anyone who depends on a robust economy.
NRPLUS MEMBER ARTICLE
each years ago Milton Friedman explained something that should never have been explained when, to write for the New York Times Magazine reminded his readers what – and for whom – a company is intended:
In a privately owned and privately owned system, a company manager is an employee of the owners of the company. He has direct responsibility to his employers. That responsibility is to do business in accordance with their wishes, which will generally be to make as much money as possible while meeting [the] basic rules of. . . society, both embodied in law and embodied in ethical habit. . . .
What does it mean to say that the manager in his capacity as a businessman has a “social responsibility”? If this statement is not pure rhetoric, it must mean that he must act in a way that is not in the interest of his employers.
The executives who adapt a company’s mission to a particular concept of ‘social responsibility’ spend the shareholders’ money on a moral agenda unrelated to the company’s goals, an insult that only gets worse when their crusade returns, the share price or both.
Friedman wrote in 1971. Since then, like so many bad ideas, corporate social responsibility has been institutionalized. To take a recent example, in 2017 JPMorgan Chase gave $ 500,000 to the Southern Poverty Law Center, an organization that has unfortunately strayed far of his original ideals. Had they heard of it, this gift would likely have annoyed many shareholders. The employee who had to justify it was – you guessed it – the head of the bank’s corporate responsibility, a title that indicates how deeply rotten.
It has been a long time since the alleged social responsibility of companies could be overcome by one or two handouts, but the pressure on them to follow an outsider’s line has intensified in recent years. Often repackaged as a requirement that companies be measured by their compliance with arbitrary and increasingly tightened E (environment), S (social) and G (governance) standards, it is now a way to effortlessly target private companies. correcting legislation. The G, which can address issues such as transparency and compliance, is relatively uncontroversial, but for many shareholders it insists on the E and, to a lesser extent, the S, which can range from the benign (worker safety) to the malicious (determine what legally products that a company may or may not sell) is a form of expropriation.
It is a sign of how deeply ingrained the ideas behind ESG have become Financial times, mistakenly thought by old fashioned to be the house magazine of capitalism, has now presumably had a section called “Moral money, ‘Billed as’ the trusted destination for news and analysis on the fast-growing world of corporate social responsibility, sustainable finance, impact investing, [ESG] trends, and the UN Sustainable Development Goals “- a rebarbative combination for which those who have FT clearly believe there is an audience.
If Davos is an indicator, they are right. Here is an excerpt from the World Economic Forum’s “Manifesto for 2020“:
A company serves society as a whole through its activities, supports the communities in which it operates and pays a fair share of taxes. It ensures the safe, ethical and efficient use of data. It acts as a steward of the environment and the material universe for future generations. It consciously protects our biosphere and advocates a circular, shared and regenerative economy. It constantly pushes the boundaries of knowledge, innovation and technology to improve people’s well-being. . . .
A company is more than an economic unit that generates wealth. It fulfills human and social ambitions as part of the broader social system. Performance should not only be measured by the return for shareholders, but also by the way in which the environmental, social and good governance objectives are achieved.
Unfortunately, what happens in Davos does not remain in Davos.
The existence of the FTThe Moral Money section is even more evidence of this larger trend. In a recent editionwe could read how a Bank of America analyst investigated the environmental impact (at least from the perspective of climate fighters) to bring supply chains closer to home in the aftermath of COVID-19. The author’s conclusion that this would cut emissions would not have worried investors in happier times – their interest would only focus on the financial implications of such a change. But we don’t live in that time.
Banks are not charities. They wouldn’t write research reports of this type unless there was a market for it, and there is. ESG investing becomes big business. So as one of the “Moral Money” teams reports:
According to research by Sustainable Research and Analysis, an independent research store based in New York, total assets in sustainable mutual funds and ETFs reached $ 1.6 trillion in 2019, growing from a base of only $ 400 billion at the end of 2018. Even with the outbreak of the corona virus that accelerated markets, ESG funds added an additional $ 500 billion in assets in the first quarter of 2020.
As you read on there is a glimmer of hope:
But only a small portion came from net new money. In 2019, asset managers changed 475 existing funds to include ESG factors, which accounted for more than $ 1tn, or 86 percent of total ‘new’ ESG assets.
So Wall Street is behaving with its usual cynicism, and in the moral universe of “Moral Money” it won’t:
At first glance, this seems disturbing and sends red flags for greenwashing.
It would take a heart of stone not to smile here, but you would laugh too early:
Henry Shilling, research director for Sustainable Research and Analysis, says that most asset managers don’t just stick an ESG label on their funds and call it a day. “Most rebranded funds have implemented ESG integration strategies,” he said, explaining that they had explicitly modified their prospectus documents to include ESG as part of their investment process and discussed ESG issues with portfolio companies.
However, being ‘involved in’ can mean sending a token memo or doing something substantive. So it’s time for some more pearl clamp:
Even with all companies making public commitments to cut emissions and watch their interests, a shocking minority has gone so far as to link executive pay to a certain ESG measure. In fact, new research from Sustainalytics shows that only 9 percent of all companies in the FTSE AW index have done this. In addition, the vast majority of those who have focused on health and safety at work only.
Only does a lot of work there.
It is worth pausing to consider the citations of Sustain analytics, which describes itself as “the leading independent global provider of ESG research and corporate governance and investor ratings”, and of Sustainable research and analysis, a company that serves as “a source of information on sustainable investment management, research, opinions and ratings of sustainable funds.” Both are part of the thriving (and profitable) ecosystem that ESG investing has created. It includes consultancies, interest groups, chief sustainability officers and many, many more tenants. ESG is bad news for investors, but it’s not a bad way to fill the wallets of those who feed on it.
All this does not deny that there is room for ESG based investment strategies. If investors want to base their stock selection in whole or in part on ESG criteria, that is of course up to them, and if investment companies want to market ESG compliant funds, that’s fine. Funds that do not invest in companies that sell arms or alcohol, for example, have been around for a long time. ESG compliant funds are simply an extension of the perfectly reasonable idea that investors should not be forced to choose between their principles and smart investments. The more choice such investors have, the better.
But choice is the key word here. Much of the pressure for companies to increase their ESG game comes either directly from state or other government pension funds, which are not exactly free from political pressure and ideological bias, or from the investment companies that want to sell to them. For example, ‘Moral Money’ reports on a number of proxy battles over ESG issues that are popping up at companies such as ExxonMobil and British bank Barclays. Among those cited as leading in these battles are Brunel Pension Partnership, which manages ten pension funds local British governments, the Liverpool-based pension fund Merseyside (also for local government employees), and – this is far from just a British thing – the New York State Common Retirement Fund.
Go to Brunel’s website, and you notice that:
[Brunel’s] investment team [has] the ability to think clearly in a span of 10 to 20 years. As such, environmental and social risk considerations, along with good governance and stewardship, are integrated into [its] decision-making processes. . . .
The main objective of our climate policy is to systematically change the investment industry to ensure it is suitable for a world where the temperature rise must be kept well below 2 ° C compared to pre-industrial levels.
Pension funds should try to achieve the best possible economic return for their retirees, who are, in a sense, regular customers. Similarly, when such pensions are financed or, in the case of defined benefit plans, fully or partially subscribed by taxpayers, there is – or should be – a duty payable to those who can hook them up. But for Brunel, other goals now seem to be in play.
An even bigger problem can come from investment groups such as BlackRock. As the FT notes that the company is currently under attack from ESG activists, despite the position of its chairman and CEO, Larry Fink, who earlier this year claimed in a letter that “climate change has become a determining factor in the long-term outlook for companies,” and further explained how:
Black rock [has] announced a number of initiatives to put sustainability at the heart of our investment approach, including: making sustainability an integral part of portfolio construction and risk management; exciting investments with a high sustainability risk, such as thermal coal producers; launch new investment products that screen fossil fuels; and strengthening our commitment to sustainability and transparency in our investment management activities.
More details are set out in one letter to customers:
We have been working on improving access for a number of years, for example by building the largest suite of ESG ETFs in the industry, enabling many more individuals to invest sustainably more easily. . . . We plan to double our offering of ESG ETFs (up to 150) in the coming years, including durable versions of flagship index products, giving customers more choice in how to invest their money.
Some of this only reflected BlackRock’s self-interest – and there’s nothing wrong with that. As noted above, a wider choice for investors should be welcomed. But there is also the fact that:
Each active investment team at BlackRock takes into account ESG factors in its investment process and has made clear how the ESG integrates into its investment processes. By the end of 2020, all active portfolios and advisory strategies will be fully ESG integrated – meaning that our portfolio managers at portfolio level will be responsible for properly managing exposure to ESG risks and documenting how those considerations influenced investment decisions.
Investors are free not to invest with BlackRock, but the fact that BlackRock is so large doesn’t eliminate the problem that this new policy could pose. Before the coronavirus crisis started, BlackRock was over $ 7 trillion under management. If a company does not adhere to BlackRock’s ESG rules, it risks shutting itself off from a potentially substantial source of capital and / or support for its share price. If a company’s management decides not to run that risk, it may need to establish a policy that damages the company’s long-term prospects. That can help the stock’s price, at least for a while, but it’s hardly a desirable outcome.
Even if a company has no interest in having BlackRock as a shareholder, BlackRock may have an interest in it. Once BlackRock takes a stake in a company, chances are it will put pressure on management, as every shareholder has the right. Most shareholders do this only to increase their returns, but BlackRock, regardless of its claims of the link between “sustainability” and longer-term profitability, has other goals:
We have been working with companies on sustainability issues for years, urging management teams to make progress, while also knowingly giving companies time to lay the foundation for disclosure in accordance with the Sustainability Accounting Standards Board (SASB) and TCFD. We are asking companies to publish SASB and TCFD targeted disclosures, and as expressed in the TCFD guidelines, this should include the business plan to operate in a scenario where the Paris Agreement’s goal of global warming less than two degrees, is fully realized. Given the foundation we have already laid and the increasing investment risks surrounding sustainability, we will be increasingly inclined to vote against management when companies have made insufficient progress. [Emphasis added.]
SASB and TCFD are two other creatures in the ESG ecosystem. The first was once chaired by Michael Bloomberg, while the second still is. SASB says it has a “mission.” . . to help companies around the world identify, manage and report on sustainability topics that they boldly claim, if incorrect, are “the most important to their investors.” Meanwhile, TCFD, the Task Force on Climate-related Financial Disclosures, says it aims to “develop voluntary, consistent climate-related financial risk disclosures for use by companies in providing information to investors, lenders, insurers and other stakeholders”, an objective with a clever twist: If companies don’t go along with these “voluntary” disclosures, their banks and insurers – part of an industry that is unusually sensitive to political pressure – can turn the screws.
As a shareholder, BlackRock has every right to insist that the management of the companies in which it invests adhere to its dictations. Likewise, other shareholders are free to insist that BlackRock be told to take a walk, after which the whole thing can be ejected at a general meeting. But many of the other shareholders will also be institutional investors. Even if they disagree with BlackRock’s agenda, they may feel compelled by commercial pressure of the type I mentioned above to go along.
In fact, many companies – and not just the publicly traded – will be forced to change their way of doing business while trying to keep up with the increasingly strict rules that have not been drawn up by democratically elected legislators but by the irresponsible, ambitious, greedy and avid. Milton Friedman would have been shocked (if not completely surprised) that activists like these ESG vigilantes could exercise such power through their ownership of shares. Today’s small investors, retirees, and anyone else who depends on a booming economy should be even more angry.