Back in the early ‘90s, while serving as a junior naval officer, my ship deployed for a six-month journey around South America. This extensive trip was marked by a total of thirty-two ports of call around the entire continent. During that deployment, one of my many collateral duties was to head up COMREL for the battle group. COMREL stands for Community Relations, and my job was to coordinate aid distribution and head up volunteer efforts in the countries we visited. I reported directly to the Admiral’s public affairs officer (PAO), and I must say we butted heads...occasionally.
I was young and idealistic, and the flag PAO was just the opposite. The previous week in Columbia, I had coordinated a successful renovation of an orphanage with the sailors of our group, which had gone straight to my head. My trusty band of sailors and I were going to save the world. Our next port of call was Manta, Ecuador, where the plan was to hand over basic aid packets at the pier to the Catholic diocese for them to distribute.
Against the PAO’s wishes, I nixed that plan and instead set up a distribution event involving our sailors in coordination with a local parish in an impoverished village outside of Manta. I wanted the sailors to be involved, and I wanted control to ensure proper distribution
Total disaster ensued. We had barely reached the village before hundreds of people, clearly in desperate need, stopped our trucks in a crush of humanity, grabbing, climbing, pushing, and fighting desperately to obtain our cargo. We had no choice but to distribute all we had there and then, in the throws of chaos.
The PAO was fuming and waiting for me at the dock when my band of dispirited sailors returned. He dressed me down one way and then the other, as I expected and well deserved. I had nearly created an international incident that was precisely the opposite of our intentions, and as the mission fell under his sphere of management, I'd created quite the situation for him to clean up as well. Later, once he calmed down, he said, “Rob, you have to accept that everyone doesn’t define “doing good” the same way, and neither your way nor others' ways will always be right.”
Is ESG Investing Headed Toward A Similar Fate?
Fast forward to today, and I can see the Environmental, Social, and Governance (ESG) investing trend is headed straight toward that same village outside Manta. The results for those who buy into it will be the same deep disappointment that my sailors and I experienced.
If you do not know what ESG is, here is the Investopedia definition: Environmental, social, and governance (ESG) investing refers to a set of standards for a company’s behavior used by socially conscious investors to screen potential investments. Investment advisers utilize this sort of metric to guide the decision-making process for individuals, stakeholders, and groups/corporations looking to invest in a certain asset.
Especially in recent years, it has become more and more common to see sustainable investors wanting to be confident that a company’s Environmental, Social, and Governance policies and actions are positively impacting the global outlook—and to identify ways that their dollar can incentivize business leaders to do even better. Basically, the theory is that there should be a mutual benefit for investors and the world at large in these investment deals.
Warnings About the ESG Investing Trend:
Now, in expressing my reservations regarding this investment trend, I feel like the Admiral’s old, crotchety PAO when I rain on this parade, but there are too many fatal issues to this concept to ignore. Let me list them out for you:
Lack of Information:
The information required to create a screen of publicly traded stocks that meet specific ESG criteria is not available or verifiable. With no framework metrics or mechanisms established to find the information needed to determine if a certain investment meets a set of standards, or to compare that investment to others that are available, it is virtually impossible to truly make an informed decision. And good investments are almost always made on the backs of strongly informed decisions.
Lack of Consistency:
There is no single acceptable screen using objective criteria. It is nearly impossible for an objective definition or standardized criteria for what makes an investment sustainable to be established. Because of this, there is a real lack of consistency or authority on what really makes an investment a worthy choice, so essentially each investor is relying on his or her own moral code to drive their decisions - this is a system that cannot last in the longterm. An investment trend in which every participant creates baskets of stocks utilizing only their personal standards based upon their own biases and definitions is substandard, at best.
Furthermore, this recent study, conducted by researchers at MIT and the University of Zurich, found very little consistency in the assessments of ESG rating agencies, proving that it is very difficult to evaluate the ESG performance of most companies.
Lack of Accountability:
This is a big one. Any board of directors of a publicly traded company has a fiduciary responsibility to their shareholders. Any fee-only advisor (like me) has a fiduciary duty to our clients. Said duty revolves around return on investment and achievement of financial objectives, not social responsibility.
This lack of accountability also rears its unsightly head in the form of the messaging that is put out by companies that claim to be profitable ESG investments. "Greenwashing techniques", which is basically when a company spends more resources on presenting itself as environmentally conscious than on actually limiting its impact on the environment. Tactics like this are widespread in marketing and sales departments that go unchecked, as so many have in recent years as the ESG investment trend has developed.
All this reporting, screening, and gymnastics around social responsibilities add expenses and fees ultimately borne by the buying public. When investors are paying the costs for new investing trends, it's time to ditch the fad.
These fatal issues have created significant conflicts of interest and opportunities for Wall Street, making interesting bedfellows to those interested in investing with a clear conscience. Basically, ESG creates an excuse for Wall Street to charge more for underperformance. Many firms have jumped on the ESG bandwagon for this very reason. Vanguard, arguably the largest asset manager in the world, has valiantly pushed back. Tim Buckley, CEO of Vanguard, said recently in an interview with the Financial Times that “Our research indicates that ESG investing does not have any advantage over broad-based investing.” Subsequently, Vanguard has pulled away from the Net Zero Asset Managers initiative in favor of their fiduciary duty to investors.
We all must be concerned about essential issues that will transform the future. Capitalism has been, and will continue to be, a significant force in that transformation, bringing about some good and some bad. Moral and ethical decisions around energy, genetic editing, artificial intelligence, and many other issues will shape what will come.
In a 2022 article about ESG Investing, The Economist began by saying "But the idea that you can make profits with purpose has recently come under pressure. Elon Musk has called ESG a scam; German police have just launched “greenwashing” raids; and insiders are spilling the beans. For something with hints of a moral crusade, ESG is in danger of turning into an unholy mess." I have to say, I agree. Click here for access to the entire article, which reiterates my point in compelling ways.
I would be lying if I said I was not worried about the decisions and regulations that need to happen the laws and initiatives that will need to be put into place in response to our rapidly changing society, and the commitment it will take to enforce such things. I don’t pretend to have all the answers, but I’m pretty sure trusting Wall Street to maintain positive involvement and take care of it for us is a terrible idea.
These are our thoughts, have a great Thursday.
~ Rob Schulz, CFP