Sustainable Investing -- The Real Deal or Bullshit?

MJ Woods's picture
Rank: Orangutan | 303

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

Comments (44)

Jun 14, 2018

I agree that greenwashing is rampant throughout companies but I also think it is sector dependent. Aerospace can try as hard as it wants but it'll have a harder time appearing as green as automotive until they make electric or hybrid planes (which are in the pipeline but still far out). The image of green works best with cheaper consumer products such as gadgets or food as volume consumption is higher, higher prices can be charged and some companies are truly trying to change or have an impact.

The issue is that the average consumer has different points of reference when it comes to what is green for them. To discuss your example of GE, I think they are working towards more sustainable initiatives but people don't look at it objectively. If GE made a new jet engine that's ~12% greener (emits ~12% less GHGs), the average consumer will still see planes as massive GHG emitting machines, although that change is objectively speaking quite high.

But sustainable investing can also be tied to sustainable impact investing at times e.g. a company that helps build solar plants in certain countries and gives the local community jobs by building them. My question is, are you just looking at sustainability or sustainability + impact?

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Jun 14, 2018

Great point on sector specificity and consumer goods. I also like your point on consumer point of reference. Ideally, I would like to see my investment dollars go towards companies that are delivering solutions that reduce negative environmental impacts as well as deliver some sort of localized impact. The whole world of impact investing. But that too, appears, to me to be story specific as to how the impact is being delivered and whether it excites me. Increasingly, I see technology solutions that may vary greatly by country and for the first time, developing nations that don't have legacy constraints, players, infrastructure, etc. may be in a better position to accept sustainable technology and solutions that deliver impact. An example being how we produce and distribute energy, or how we move people with autonomous and/or electric vehicles.

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Jun 14, 2018

I've fallen in love with aerospace and air travel lately so two companies I would recommend are:

  • Wright Electric: the startup behind making fully electric planes with backing from easyJet
  • BoomJet: the company making a new concord style plane but making it quieter, faster and as costly as traditional business or first class (so competitive for the segment it targets). They already back both backing and pre-orders for Virgin Airlines and Japan Airlines.
Jun 14, 2018

You don't have to like Cliff Asness, but he does have a point 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?

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Jun 14, 2018

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.

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Jun 16, 2018

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!

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Jun 17, 2018

Thanks for your commentary. Do you engage with mgmt teams that meet your ESG screen and you're engaging them to be better corporate citizens or are you engaging companies in some other way? What are two companies that you admire and why? Thanks!

Jun 23, 2018

We will engage across strategies, whether ESG or not. Pooling assets gives us more clout.

My primary engagement goal is to bring the concept of good corporate citizenship to their attention. We do plenty of other things, arguing for specific causes.

Good question on the two companies. As I think about how to answer this question I find myself focusing on the quality of management teams. The CEO sets the tone.

I am a Zuckerberg fan. Never met him in person. Haven't even heard 2nd or 3rd hand accounts, but I've followed his public engagements and FB's various initiatives. He is a visionary who understands the immense power and responsibility of what he is doing. In my opinion FB is the most powerful and valuable company in the world. Others don't know it yet, but Mark does. His company is creating the digital social fabric that he intends us to use ad infinitum.

It's tough to find companies like FB that have such wide reaching impacts but there are a number of other companies where I admire management and the corresponding business model. LRCX, RCL, ULTA, BBY are coming front of mind. The new TSN CEO is a great ESG marketer and may be authentic, tough to argue with what he is doing.

Most Helpful
Jun 26, 2018

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!

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Jun 26, 2018

Long NCLH not RCL. Sorry.

Jun 14, 2018

In college I thought ESG was just a bunch of academic hippy stuff, but in my AM we are having conversations about ESG constantly, working on ways to incorporate screens into client portfolios. It's seriously growing, especially among public institutions that want to avoid backlash and have mandates to invest assets non-controversially.

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Jun 14, 2018

That is very interesting to hear and what I'm trying to dive into with more depth is just how do we translate that desire among investors to place their investment money with companies that "first do no harm", so to speak, with these movements that are using various labels like ESG and impact investing and sustainable investing and so forth. I guess it may be much easier for people to agree with one another on what doesn't qualify, as Squirrel spoke about, the sin companies, that it is to agree with what should be included, as G-I spoke about in his post.

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Dec 12, 2019

what are your screens based off of? How is the screening process done from what you have seen implemented in client portfolios? Thanks for any input, i'm new to this topic and learning.

Jun 14, 2018

There's been a lot of talk about it for a few years now, but not many actual flows into ESG strategies. A lot of old school investors still have an issue with the belief that by limiting the opportunity set, they can generate higher returns. The alternative view is that assessing ESG risk factors helps you avoid the tail risk associated with poorly ranked companies. You won't have to deal with oil spills, or other headline risk that might make your investors nervous.

One of the main issues with ESG investing is that everyone has a different definition. While some religious organizations can invest in their "ESG" fund, it may exclude something that a university student group does not care about. On the whole, they will tilt investors towards asset lite businesses (IT and HC) as those sorts of businesses aren't going to have a high carbon metric or whatever you're scoring the companies on.

As for measuring governance you can do a few different things that do such as frequency of accidents in company's factories, equitable pay structure, board composition etc.

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Jun 15, 2018

Excellent critique. Many good points. Thank you for sharing!

Jun 17, 2018

It's obvious that anything more ethical is going to generate lower returns. The idea behind ESG is that an investor is willing to get marginally lower returns (or accept higher risk), in exchange for having his investments in a slightly more moral universe.

It's true for all of us to a certain degree. For example, I was recently offered to invest in a lawsuit settlement product with a 25% annual coupon - upon reading about the exact nature of the program (they buy out lead poison settlements for pennies on a dollar), I declined. While I happily invest in tobacco companies, I don't like agricultural companies involved in factory farming etc.

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Jun 17, 2018

So I invested in Chemours when it was spun out of Dupont, and holding it for about 18 months led to a 10x return. I became aware of the company through an investing buddy who had retired from Dupont a number of years prior and knew of the guys and their reputation for running a good operation. I liked the story b/c they produce a very high performance product called Opteon which is a low GWP refrigerant for stationary applications. This investment was anything but sacrificing return while supporting a "greener" product that is better for preserving our ozone layer. Am I missing something?

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Jun 17, 2018
MJ Woods:

Am I missing something?

I don't really know much about the company or the product, but certainly it's a good thing if you are able to get good returns on an ethical investment.

Like everything in investing, it's not a 100% certainty that your ethical investments will underperform. In general, however, unethical/unenvironmental practices have positive expected value for the company at the expense of the society. For example, it's much cheaper to hire Vietnamese children as opposed to paying full price for adult labour, it's much cheaper not to install cleaning facilities on the industrial waste lines etc. There is also a more quantitative aspect of limiting your universe to the smaller set of companies that decided to lean towards ESG practices.

Personally, I am willing to give up some sliver of expected returns in exchange for knowing that my money goes where my conscience is. My sense is that the new generation of investors (i.e. Millennials, who actually have a very high savings rate) care about it and this investing model is going to grow as they reach their prime investing years.

PS. Some green technologies are already way better than the old non-green ones and it's our inertia that's stopping up. For example, I did a test ride of Lightning Cycles two weeks ago and now can't imagine why anyone would buy anything but an electric motorcycle these days.

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Jun 23, 2018

Still a good buy here :)

Jun 17, 2018

Yes, for a long term investment. People would prefer to have a lower ROI if they know that their investment is ecologically sustainable. Especially in the near future, where we encounter a lot of issues of pollution, low supply of oil and increased global warming. There are a lot of ETFs out there that promote this already, with increasing liquidity.

Jun 17, 2018
zPanda:

Yes, for a long term investment. **People would prefer to have a lower ROI if they know that their investment is ecologically sustainable. **Especially in the near future, where we encounter a lot of issues of pollution, low supply of oil and increased global warming. There are a lot of ETFs out there that promote this already, with increasing liquidity.

I would prefer to have a higher ROI AND know that my investment is ecological sustainable. Electric vehicles and the battery technology that propels them may offer superior returns if companies like Tesla and Geely are successful.

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Jun 17, 2018

I think if you look at fundraising for pure play infra PE particularly in North America and Europe you can see that ESG and sustainable investing is no joke. I think the way investors will get away from "greenwashing" overtime is by allocating capital away from more mixed use assets particularly within the energy segment.
I think the theory behind investing in firms with strong ESG policies is rooted in mitigating downside risk and it is likely safer in the long run. If you know a firm isn't going to mess up because of management's commitment to the environment or social problems then you won't get the ills of BP, or a Transocean/Halliburton.

Jun 17, 2018

Thanks Canadian EB,

I can see that logic, though, some energy companies that tried to differentiate themselves by being more green than the industry as a whole got killed. David Crane with NRG comes to mind. What do you see happening with Canadian nat gas? I have some shares in Birchcliff and like their low cost producer, integrated gas plant strategy. Do you see LNG playing out for Canada? I also wonder what's going to happen to big food. Campbell Soups CEO Denise Morrison's plan to remake the company into selling healthier foods backfired. Coke, Pepsi, Kraft Heinz, Nestle and others are struggling to reinvent themselves after decades of dominance. Any thoughts on what's going to happen there?

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Jun 17, 2018

I get that people make up for the delta in EV through emotional gains but imo buying Constellation Brands when it's undervalued due to SRI-related selling and using the subsequent gains to do something to benefit society is, imo, a much more impactful thing to do

Jun 18, 2018

Interesting idea. Why are they selling Constellation Brands?

Jun 27, 2018

A lot of great information and discussions going on here. Another resource I thought I might add to this convo would be the Global Impact Investing Network. They're focused on advancing impact investing in the broader investor community (via standards, research, white papers). I think most don't appreciate the difference between ESG and impact investing. Similar to the point from GI Pharma Guy above.

https://thegiin.org/impact-investing/

Jun 27, 2018

Thank you for the comments and the reference Moutainguy!

Jun 27, 2018

This is the best paper on ESG by the guys on PanAgora. They are using it in their alpha process. PanAgora is a very top notch quant shop for both market neutral and long only.

https://www.panagora.com/wp-content/uploads/2018/0...

Jun 27, 2018

Thanks for sharing the reference paper from PanAgora, DeepLearning. I pulled out this particular quote to share, noting that we can have alpha and downside risk protection while making values based investments:

"With the newer Integration and Impact approaches, the investment community is beginning to realize that ESG and alpha generation are not mu- tually exclusive. Our research, in fact, shows that in many cases including ESG conscious firms in a portfolio can be additive while also providing down- side protection. "

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Jun 27, 2018

Good quote. It's also important to note that ESG has varying efficacy among different regions as well as different economic cycles.

Jul 26, 2018

Miss me with that bullshit. ESG is a wasteful PR stunt. Invest normally, and then if you want to, donate to your favorite charity.

Jul 26, 2018

MJ Woods, bummer your thread hasn't had a response yet. Maybe one of these threads could point you in the right direction:

  • Oil and Gas Overview more gas is consumed. Per usual post up extra comments/questions. Energy Investment Banking to Tuesday, ... changes in Nat Gas prices (movements of more than 10-20 cents on a $/MMBtu are material). OPEC: The next ... Gas prices (movements of more than 10-15c on a $/MMBtu are material). Weather: One small overlap with ...
  • Sustainable Investing-- The Real Deal or Bullshit? a bunch of press on Sustainable Investing. It comes in many flavors but one flavor is known as ESG. It ... missed the boat on many new green energy opportunities. Battery storage comes to mind. In some consulting ... thoughts?! MJW Sustainable Investing ESG to Tuesday, June 19, 2018- 4:55pm ...
  • Upstream Oil & Gas Engineer to Energy Investment Banking Resume utilize my time more wisely if I went straight from oil & gas engineering/geoscience into investment ... Financial Modeling and Oil & Gas Modeling to improve my more practical modeling skills. I have attached ... Florida and have spent the past five (5) years working around the world in upstream oil & gas ...
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  • AMA- Non-ranked undergrad 'ORM' with a 660 GMAT who got into multiple top 20 programs out more than I could ever ask for. Quick shout out to a few members who greatly helped me on my ... journey (Mod Note- I moved the shout outs to bottom of the post). I got into multiple top 20 programs with ... ended up getting waitlisted). I think what is more important than that is to show real interest and ...
  • More suggestions...

No promises, but sometimes if we mention a user, they will share their wisdom: @olena.ostasheva @shramana @MidMarketMcLovin

Hope that helps.

Jul 26, 2018