A Prosono Opinion on ESG Investing
James Mackintosh is a notable columnist and purveyor of opinion with regard to financial markets. One of his more current pieces, “ESG Investing Can Do Good or Do Well, but Don’t Expect Both,” is informative, but not complete. If you have ever watched the Eddie Murphy classic, “Trading Places,” you are familiar with the old-school adage: When investing, the goal is to buy low and sell high. This will likely never change, but ESG investing is not about the old-school methods. It is about a new paradigm of thought and behavior when it comes to investment opportunities.
Mackintosh devotes his argument to the circumstance that green products are overpriced. This may be the case, due to the supply/demand mismatch. Rather than dismissing ESG as a bloated objective, we assert the overall return potential of true ESG investing will be guided by growth sectors. So while there is record investor demand along with an incredibly limited supply of mature companies, climate tech and social enterprise markets are forecasted to have the largest growth rates. According to Larry Fink, “companies that have a market valuation over a billion dollars, won’t be a search engine, won’t be a media company, they’ll be businesses developing green hydrogen, green agriculture, green steel, and green cement.” These technologies and markets are new and that begets some product immaturity, as well as less information for the customer base. We agree with Mackintosh in his statement, “Simply buying good companies is not a route to outperformance.” It must be a financially viable business in a promising market.
As we look to examine costs and returns, it is important to note that the bond market in 2021 suffered. Bond yields fall with demand, and the demand for ESG is at its highest – ever. Due to the demand, investment managers are charging a premium (some over 40%), and this may contribute to the 0.02% underperformance vs. bonds that Macintosh cites. According to Bloomberg Finance’s, Tariq Fancy, formerly of BlackRock, “ESG funds, including ESGU, generally charge investors higher fees on average than their non-sustainably labeled counterparts. ESGU’s fees are lower than industry averages for sustainable funds, but are still five times higher than an S&P 500 tracker that trades under the ticker IVV -- a popular BlackRock fund whose makeup and expected performance are closely aligned with those of ESGU.”
Regulations of ESG are modest, and the content of these bonds may be vastly differing and not necessarily true ESG. For many, ESG is essentially risk mitigation. For example, the underlying asset of a wind farm, backed by a green bond, will more likely outperform the bond-backed coal plant. Over the asset’s useful lifetime, the coal plant is likely to be turned off. Ultimately, ESG investing is about new areas of potential, the long-term perspective, and overriding the short-term lens of quarter-by-quarter fiscal reporting. Just as the goal of ESG is to create products and markets with long-term viability, the goal of ESG investing must also be with a long-range plan at its core.
Corporate enterprises that have an interest in the zeitgeist of social trends are adopting and adapting to ESG investing. A company such as The Gap, founded in 1969, has long held the philosophy that doing ‘good’ is good for business. Donald Fisher, the founder, recognized that a company should be a reflection of the greater community and charitable efforts by the company and its employees could only enhance goodwill feelings both internally and externally. Our position is a patient one. We believe that ESG Investing can do ‘good’ and do well, but perhaps one should not expect both immediately. Investments, research and results take time. It is about finding the right fit. Mackintosh writes, “If ESG truly offers reward to investors, it brings no virtue. If it is virtuous, expect a lower reward.” Perhaps his cynicism intends to drive his point. Prosono knows that financial reward is not a quick endeavor or a quick fix. We also know that virtue in and of itself is a reward.