December 17, 2023
A Critical Look at ESG Sustainable Investment

by Denis Kleinfeld

ESG Sustainability is all about money. According to Private Wealth (September 16, 2019) wealthy families pour fortunes into the US$31 trillion ESG global opportunity. The Forum for Sustainable and Responsible Investment Biannual 2018 Report states that sustainable and impact investing in the United States continues to grow. Investors consider environmental, social and governance (ESG) across US$12 trillion of institutionally managed assets (91 per cent being from public investment funds and insurance companies), a 38 per cent increase since 2016.

An article from Investment News, July 12, 2019, points to an increased focus on the environment in 2014 as a tipping point in the ESG space as the interest among investors started to outpace the supply. That increased demand resulted in a flood of new mutual funds and ETFs that employed ESG strategies.

The essence of ESG involves the idea that some investors desire that an allocation of their investment capital should be prioritised for climate change, social justice, and for corporations to be good citizens of the global community. For ESG sustainable oriented investors, compliance with ESG investment factors makes them feel that they and, concomitantly, the planet earth is sustainable.

The Paris Agreement reflects the policies of a large number of non-governmental and governmental bodies that intend to spend trillions of dollars in restructuring how energy is produced over the entire world. In order to do this, massive amounts of money will have to go from the industrial first world countries to bring second and third-world up to equality.

In Western Europe and in the United States, politicians find supporting the green new deal a way to divert voters’ attention from their ongoing policy failures, garner special interest votes, get campaign contributions, and be re-elected. Bureaucracies justify both an expansion of economic control over citizens and a bigger budget. Government grants and programmes provide financial support for legions of university and think-tank academics and scientists. And the taxpayers foot the bill.

The vast investment industry understands that wrapping themselves around the ESG sustainable investment flag allows them to recapture some of their well-deserved lost reputation, public trust, and investment funding. It gives the world-wide money industry, (defined by the all-inclusive term “Wall Street”), an opportunity to relabel, repackage, and recycle old tarnished investment products and services as new and investment worthy. Even virtuous.

Investors are led to believe that by buying into these ESG sustainable products and services they join in with the efforts of other self-anointed righteous global citizens to radically transform existing fossil fuel driven economies in order to save planet earth from extinction.

This is not happening in a vacuum. Investing money, managing wealth, or creating and running a business are, even in the most ideal of circumstances, a dauntingly complex undertaking presenting puzzling questions. Paraphrasing Mark Herrmann (The Curmudgeons Guide to Practicing Law), there is no simple question. You cannot answer a question without knowing the context in which it occurred.

Giving Context to ESG Beliefs

Bloomberg Businessweek (October 14, 2019) contains an interview with Andrea Illy, Chairman of Illycaffe, Spa (the international coffee company). The interview is highly instructive and gives context to the underlying emotional draw of people believing in sustainability aspirational standards.

A conference by The Business Roundtable, attended by Ms. Illy, posited that corporations should not focus only on shareholder value. Many attendees did not see things that way. Ms. Illy said the critics were spreading “misinformation” using, “a very old-fashioned argument supporting the theory of shareholder value”.

She sees the importance of sustainability in terms of reputation. As any good propagandist or advertising executive knows, perception is reality. The argument Ms. Illy presents is that if consumers do not see you as a “sustainable” business, they will buy less because of the low reputation. This then diminishes cash flow ultimately impacting net present value.

Ms. Illy explains sustainability in the Illy company business model as the stakeholder model favoured by ESG theory. This is opposed to the “old-fashioned” shareholder model. She explains, “The theory of shareholder value is typical Wall Street. Cash flow, profits are for shareholders to increase their wealth.”

“In the stakeholder model, there are many more parties involved. In our case, we have a hierarchy: consumers and customers, then our business partners, then our suppliers who produce coffee beans. Then at the bottom of the pyramid, the shareholders.”

A business operation can switch products, get different customers, use new suppliers, replace management. However, only the shareholders—the owners—of a business’s are irreplaceable. It’s capital investors that have skin in the game and risk exposure to the ultimate financial loss. “Growth is not a goal per se,” says Ms. Illy. Her reasoning is that the Illy company’s predominant purpose is to be coherent with ethical values and sustainable quality. This conflates the ideal of being a virtuous company with the reality that maintaining business growth and cashflow are the determinant of survivability.

Looking at this objectively, the stakeholder and shareholder models factor in similar corporate governance, ethical values, and social propriety objectives. These are concerns that are within a company’s control.

It is the environmental issue, meaning climate change public policies, where there is no agreement. Radically transforming the international industrial economy is outside the control of a business. At the heart of this are two questions. First, should the investment capital, private or public, be mandated by the government or chosen in the free-market? Second, should the means of production be controlled by government or by the private economy?

It appears that to Ms. Illy, (and like the opinion expressed by Investment News), that the fundamental meaning of sustainability follows from her belief that “the mother of all causes is climate change. We must reach the Paris goals. From 2020 to 2030, we need to reduce emissions by 50% and become carbon neutral entirely—the entire world—by 2050.”

The “Paris goals” are premised on the assertion that the earth is warming and will continue warming unless stopped. Climate computer models used by the Paris Agreement predict that increasing CO2 from fossil fuels are the cause of global warming. It presents an existential threat to planet earth. The predictions from the climate models are considered scientific proof by the climate change believers.

Certain assumptions are implicit in the climate change/CO2 modeling. Some of these are, for example, that the algorithms used in the computer models include all the variables that involve what causes weather over short and long periods of time; that the data used currently is all-encompassing and accurate; that erroneous prior predictions are irrelevant; that the algorithms reflect as a scientific fact the perfect temperature for the earth.

Everyone abhors pollution, wants clean water, efficient and safe infrastructure, universal sanitation, plenty of healthy food, garbage free oceans, safe toys, happy employees, and vacations on South Beach in Miami. These and other objectives everybody in every country is working to achieve right now.

Another way to look at this is by examining what are the results experienced by modern industrial states which have begun putting into effect replacing fossil fuel energy generation with so-called renewable sources of energy production. Are any countries trying to meet the Paris Agreement Goals? If any are trying, what is the result?

The Climate Change Experience

To date, of the 197 countries signing the Paris Agreement under the United Nations Framework Convention on Climate Change 187 have ratified it. One country, the United States, is withdrawing.

The United States has dramatically increased its fossil fuel production becoming the largest energy producer in the world. Its CO2 emissions, according to the IEA, had the largest absolute decline in carbon emissions among all countries since 2000. Only two countries, Gambia and Morocco, are meeting their emission goals.

Enormous differences in geography, demographics, culture, language, politics, and religions makes harmonising the internal interests of any country with international governmental aspirational standards impossible. The major nations of the world threaten each other militarily and economically. Among other countries, most have civil strife and others are engaged in actual warfare. None of the algorithms used in the climate models factor in the variable that the world is populated by homo sapiens who are by nature volatile and divisive.

The United Nations is reflective of the hostility that exists between nations and people within countries. Many of the member countries are led by dictators, thugs, and despots. Their citizens are not happy campers. Many remaining countries, such as those of the European Union or Canada, have demonstrably incompetent political leadership. Brexit reflects the disunion and disharmony of the political incongruence that exists even among nations which have substantial common history. Against this backdrop, what is the possibility of the nations of the world working in harmony to create a fossil-fuel free global economy?

The US is unique. Unlike any other country in the world, its government got out of the way of its private energy sector starting with the election of its new President in 2016. The US economy is, at present, the most prosperous the world has even seen by expanding its fossil fuel production.
Germany has taken the opposite road by making huge investments in “renewable” energy generation. The result is Germany electric power usage is the highest in Western Europe and by necessity it is using more coal to maintain reliable energy generation.

The Paris Agreement has not made much of an impact on the operations of investment funds. When it comes to going green and promoting climate change, the fact is that regulated investment fund professionals do not put their investment dollars at risk to achieve non-financially meaningful goals. The Financial Times noted that, “Big US fund managers that have promoted their credentials in tackling sustainability issues have done little to support environmental and social shareholder proposals, their voting records show”. Essentially, management, in opposing these shareholder proposals, sees little financial value in adopting policies that will result in below-market-rate returns to investors. Notwithstanding their contrary public pronouncements, the reality is that fund managers agree with management.

Private companies, such as Illy, for example, and private foundations are free to risk their own money, or give it away, to support any higher calling necessitated by their personal beliefs. Institutional investment fund managers and public corporations do not have this same choice. Limiting the choice of possible investments is, in general, not giving an investor the best chance for a competitive financial return. Unlike government, public corporations, licensed security dealers, brokers, wealth managers and a whole host of financial advisory and consultancy service businesses have fiduciary obligations when it comes to being accountable for dealing with another people’s money. They are subject to complex governmental financial regulations which means they could have civil or even criminal liability. Yet, ESG compliance is not an established legal defense to a claim of breach of fiduciary duty.

US Securities and Exchange Commission (SEC) reporting companies, and private corporations following their lead, basically avoid public relations difficulty with climate change activists by using rather vague language in describing their efforts to meet climate change standards and objectives. The SEC stopped prodding companies on making disclosures in 2016 and has been silent on the matter ever since.

Many investors opt out of using funds and instead invest directly in companies they determine have impressive environmental, social, and governance attributes. Some investors like solar power producers while others prefer weapon manufacturers. That’s the beauty of the free-market.

Conclusion

The investment industry, that is the professionals who handle other people’s money, promote ESG investment opportunities to attract more money under management. It gives people the chance to do well financially while believing they are doing good.

Investors have been slow to adopt sustainable ESG investing. The investment industry heavily promotes environmental, social, and good corporate governance as the future. Measuring whether an investment qualifies as ESG is not yet ready for prime time. There simply are no standards. How the data is collected and sorted in order to determine the size of the ESG investment sector varies considerably. Publicly held corporations and even private companies normally work hard to comply with labour laws, discriminations, laws, environmental laws, and a whole host of matters that are also considered as falling under the ESG label.

When it comes to promoting a radical transformation of the economy to being fossil-free or fossil-neutral, the ability to quantify the integrations of climate change policies is still not possible. What is clear is that the major industrial countries of the world, excepting Germany, are making investments in green technology but are not yet fully committed to going green. This alone may well account for hundreds of billions of dollars of so-called renewable energy investments being made over the foreseeable future. However, it is possible that the world’s economies are becoming too fragile and cannot afford to take such a costly gamble with their economy.

It should be expected that philanthropic organisations, governmental bureaucracies, universities, think-tanks, and other related organisations will continue to include ESG and climate change investing in promoting their services or in their investment portfolios. Whether socially responsible, sustainable, green investing becomes mainstream is still up in the air. Without measurable rating standards it is hard to know who is really complying and who is merely giving lip service. As Yogi Berra once said, “It’s hard to make predictions, especially about the future”.