Friends,
As an investor, I'm always looking for an edge. Do I have industry specific knowledge that provides unique insights? Do I have a longer-term investing horizon that can allow me to hang on while others jump and off looking to ride short term volatility?
I'm reading and seeing a bunch of press on Sustainable Investing. It comes in many flavors but one flavor is known as ESG. It stands for environmental, social and governance factors, and the general idea is that companies that care about the environment, building social equity, and good governance do better and perform better.
Barron's, in fact, ran a story this week that suggested ESG is a marketing angle for managers who want to appeal to women and millennial because these two groups care more about ESG. Meanwhile, men tend to focus just on performance, apparently (I guess I'm missing the boat).
One thing I find lacking about the ESG bandwagon is it's kind of hard to put your hands on exactly what it is? Is GE an ESG company? They had a whole "ecoimagination" campaign around how green they are but then again they have missed the boat on many new green energy opportunities. Battery storage comes to mind. In some consulting work I did a couple of years back, I asked an assembled team of GE engineers from across the country whether they had or were contemplating a tier-3 locomotive that could run on a biodiesel blend. You could hear crickets.
Then there are green companies that are truly game changers in the world of energy like Tesla. Yet, I'm not so sure ESG measures really capture the value and the opportunities very well. It seems to me some companies are rubbing nickels together and calling themselves green while others have the potential to be true game changers in some way, whether its how we consume energy and emit pollution or new ways to stay healthy or kill cancer.
Finally, I've never really understood why the G belongs with ES? Good governance need not be backed with triple bottom line thinking. It ought to be foundational for all companies. And how do we measure good governance anyway? Interested in your monkey thoughts?!
MJW
You don't have to like Cliff Asness, but he does have a point https://www.aqr.com/Insights/Perspectives/Virtue-is-its-Own-Reward-Or-O…</a">here. "Pursuing virtue should hurt expected returns" is the gist of it - you're paying for the ESG premium so why would you expect to perform better than you otherwise would have if you haven't imposed that constraint upon yourself?
Interesting article. Cliff's thesis appears to be that sin investors, for example, in cigarette companies make more money b/c virtuous investors serve as a constraint on the supply of capital to these companies and all else equal the sin investors need to be paid more to attract their capital. I'm not sure I buy that argument, or the corollary that virtuous investors "constrain" themselves into accepting a lower return because we have "white hat" and "black hat" companies. I just don't think the market parameters are all that clear as to what the heck ESG is in the first place. Most may agree that cigarette companies don't belong in a ESG portfolio but I'd suggest their return characteristics are independent of the universe of ESG investors. Cost of capital is more a function of the riskiness of the future cash flows and for cigarette companies much of their return has little to do with what is happening on home US turf. It's about overseas markets continuing to sell death sticks to vulnerable populations. As for ESG companies, I don't really know what those are universally? I can think of a company like Marine Harvest that is a cash machine and the world's largest producer of farm raised salmon. I might consider that a leader in sustainable fisheries management and therefore it may or may not be a good candidate as investment. Part of the reason I like it as an investment is that it is careful about its production practices. Another factor is that it has scale and depth of experience such that it is a low cost producer and has large market share. Another advantage is that is it backed by shareholders with a long-term investment horizon and like land being a resource that is limited, there are only so many places one can raise salmon successfully in the ocean.
The problem with Cliff and everyone else that subscribes to economic theory is that they think that people are "rational" in their decisions at every moment. Actually they don't really think that but whatever, it underpins their life's worth.
To your other points, my firm markets ESG pretty effectively. We engage with IR teams and file shareholder resolutions. What we go for is common sense. Treat your employees with respect. Foster a culture of authenticity. Be kind, patient and wise.
It can sound stupid but it obviously matters. It doesn't mean that hardship is avoided. Hardship can stimulate massive innovation.
But.
IMO ESG is valuable at the tails of investment. That is to say, I like X company but gosh why do so many file lawsuits against them, or why do regulators hate them, or why do consumers hate them. Why fight that battle? Conversely, if the employees love the company, and employees love the company, and consumers love the company, that can't be a bad thing!
So I took a look at LRCX, RCL, ULTA, BBY and TSN. I have an investment in RCL which I like for their smaller sized fleet, higher end market segmentation, and focus on right sizing the company. What makes LRCX a good investment story plus a ESG story? ULTA I don't know much about, same question what makes it a good ESG story? BBY, up and down, the company of nine lives, but selling appliances is being green? Also their corporate governance has been somewhat erratic. TSN, is somewhat close to home here in Iowa. Now, I could argue that TSN is anything but a ESG type company. Vertically integrated and squeezing producers, horrible environmental record with confinements both from environmental and animal welfare among other concerns. Here in Iowa we grow about one third of the nation's pork about 50 million animals per year. But we need a better way to manage the waste (Iowa is a major contributor of nitrogen to the gulf hypoxic zone with manure runoff through tiling being a contributing source) and harness all the methane that is going into the atmosphere as the manure ferments in our barns with the animals living most of their lives above their decaying waste. Interesting pull out section in the WSJ today on sustainable investing. Really interested in how you (we) evaluate these companies with respect corporate citizenship, shareholder friendly management, while identifying companies that have the ability to outperform financially. ULTA has appears to have had some steady growth, the others are not one's I guess I would have identified as potentially attractive from an investment standpoint. But I may be missing parts of the story!