Many readers will be aware that one of the biggest investment themes in the last few months and years has been something called “ESG”. In Europe alone, ESG funds attracted not far off half of all new investment flows in 2020 – a total of €223 billion!
ESG stands for “Environmental, Social and Governance”. The basic idea is that the more “ESG” a company or fund is, the more “ethical” you can consider them to be across three broad areas:
Environmental – This is perhaps the most “obvious” of the three components. It will look at things like a company’s impact on climate change, energy consumption, resource depletion, pollution, disposal of hazardous waste, deforestation, impact on biodiversity, animal welfare and so forth.
Social – will seek to look at a company’s impact on all of its stakeholders, and on society as a whole. Put more simply – you might think about this as being about their impact on people. This would include things like conditions for their employees: Fairness, diversity, labour rights, working conditions and so on. A company scoring well here would also demonstrate that they were mindful of the same factors at work with their suppliers. It might be great to work for a Californian tech’ company or British fashion designer in Los Angeles or London but not so great to work for the Chinese company supplying them with components or Sri Lankan company shipping them clothes. It is probably pretty edifying to be a master of the universe hedge fund manager in Singapore or Sydney, but not as attractive being the minimum wage person in Bangalore building financial models for them overnight. A company should only score well here if they can demonstrate they’re thinking about all of the above.
Governance – examines how well a company addresses things like the use of accurate and transparent accounting policies, executive pay, and their treatment of shareholders, particularly in terms of their voting rights and their ability to exert control on a company’s management when needed. It would also look at potential conflicts of interest, in the choice of board members for example, or where a company might make political donations. Interestingly, big tech companies, which might otherwise seem like quite enlightened, "good actors" often perform pretty badly here given concerns over things like data misuse, tax avoidance and higher voting rights for founder's shares versus everyone else's. (More on this topic can be found here under the header "Poor social performance due to governance structure" if you're interested).
ESG will also want to take account of a company’s involvement in “sin” products such as alcohol, tobacco, guns or other armaments and defence products more generally.
A key point I would make about ESG as a whole is that it is a very complicated and subjective area. It is hard to be black and white. The ESG credentials of any given company or investment are inherently very difficult to establish. Information about a big company will often be highly imperfect and, even if you can get accurate information, there is a huge element of subjectivity and judgement when “scoring” such things. By extension, it is even harder to establish the aggregate ESG credentials of a fund which may own hundreds or even thousands of companies.
If you just focus on the “Environmental” bit, for example: Copper requires a great deal of energy to mine but there could be no electric cars without it. An oil company is very clearly a “carbon” company - but how might we legislate for, say, a large medical logistics company delivering life-saving products but using a fair bit of diesel and aviation fuel in doing so? I would argue that the more you think about how interconnected everything is, the more bewildering it is and the harder it is to draw hard and fast conclusions about such things.
When it comes to “Social” and “Governance” - during our careers, many of us will have had direct experience of working for a company with a “fantastic” reputation and brand and then marvelling at just how rotten and imperfect it is when you’re on the inside. Even if you work for a wonderful company that you love and that you’re very proud of, how many times might you have heard your friends and peers tell stories about how hopeless their company is and say things like “if people only knew what a disaster we are”? I’ve lost track of how many times I’ve come across such sentiments in more than twenty years of working with people at some of the “greatest” companies in the world!
The direction of travel is encouraging
This all having been said, in a recent video interview, I made the point that I feel strongly that most companies are becoming “more ESG” over time for several inherent, structural reasons. Basically, because all, or most of their stakeholders are forcing them to.
You can see my comments and those of our collaborator, Professor Andrew Clare, from minute 44 to about minute 50 in this video.
(You may need to enter this passcode to view the video by the way: 4Y28bsi%).
The broad point here is that there is an inherent “micro” push at many companies in the world towards being better corporate citizens, because of the impact of the people who run those companies, work for them, buy from them and invest in them nowadays.
Not that long ago, many companies were run by “rich, old, greedy, white men”. Many of the investors in those companies were cut from the same cloth and relatively few of their employees or customers thought that much about whether a company was exploiting minimum-wage workers or damaging the natural world.
I would argue that this has changed very significantly in my lifetime and particularly in the last twenty years or so.
There is a “supply” push element to this, in that a very significant percentage of companies are actually run by people who care about all things ESG just as much as the rest of the population might. There are plenty of companies where management and employees have a real sense of mission about such things. I have seen this first-hand in the healthcare industry. Recently, one of the members of our online Community expressed concerns about the behaviour of big pharma companies. I was able to tell him, hand on heart that, contrary to what many people believe, I have found that CEOs, divisional management, and research staff in such companies are driven far more by a passionate desire to improve patient care than by greed, truly. That has been my experience in more than six years working with dozens of such companies.
Even where management teams might not be inclined to be good corporate actors out of personal choice, there is a powerful “demand pull” factor at play here, in that they are effectively forced to be good actors or face real problems hiring young staff, attracting capital, and selling their products to consumers who care about such things more than ever before.
We can see this in popular culture: Julia Roberts won the Best Actress Oscar in 2001 for her portrayal of US activist Erin Brockovich. The film of the same name told the story of how Brockovich took on Pacific Gas and Electricity Corporation, one of the biggest utility companies in the world, and secured $333 million of compensation for nearly 200 people who the case found had been poisoned by the company over many years. This was a real wake up call for corporate America, hence the success of the film, and illustrative of just how much the mood music had changed by 1996 when that court case took place. This sort of outcome simply didn’t happen previously. Someone like Erin Brockovich could never have secured that result in the 1950s, 1960s, 1970s or 1980s.
Above, I have suggested there is a “micro-pull” towards ESG down at the level of the company. There is a fair bit of evidence that there is a related top-down “macro-push”. That is to say that, increasingly, the world’s biggest and leading companies are unilaterally deciding to put ESG centre-stage in much of what they do.
There are myriad examples of this. Unilever is one of the biggest consumer products companies in the world. In 2020 they sold just under €51 billion worth of many of the products we use every week in 190 countries. Their brands include Dove soap, VO5 hair products, Hellman’s mayonnaise, Ben & Jerry’s, Cornetto and Magnum ice cream, Lipton tea, Domestos bleach and Persil washing products – the list is very long.
In June of last year, they announced:
“…a new range of measures and commitments designed to improve the health of the planet by taking even more decisive action to fight climate change, and protect and regenerate nature, to preserve resources for future generations. Unilever will achieve Net Zero emissions from all our products by 2039. We will also empower, and work with, a new generation of farmers and smallholders, driving programmes to protect and restore forests, soil and biodiversity; and we will work with governments and other organisations to improve access to water for communities in water-stressed areas.”
…and set up a €1 billion “Climate & Nature Fund”.
In the investment industry, specifically, as I said in the video I linked to above, BlackRock is one of the biggest investment companies in the world, possibly THE biggest on any given day. They are in charge of more than $7 trillion of client assets.
Last year, their CEO, Larry Fink, wrote a letter to thousands of CEOs around the world entitled “A Fundamental Reshaping of Finance.” The letter included headings such as “Climate Risk is Investment Risk” and
“…announced a number of initiatives to place sustainability at the center of our investment approach, including: making sustainability integral to portfolio construction and risk management; exiting investments that present a high sustainability-related risk, such as thermal coal producers; launching new investment products that screen fossil fuels; and strengthening our commitment to sustainability and transparency in our investment stewardship activities.”
In the nasty old oil and gas industry, only a few weeks ago the Shell CEO Ben van Beurden announced the company’s intention to be “…a net-zero emissions energy business by 2050 or sooner...” and they are by no means the only massive company in that sector with similar aspirations.
It is often forgotten, for example, that the oil majors are the biggest investors in clean energy technologies, committing $9 billion in 2020 alone. This is not surprising when you see headlines such as “Institutional Investors Are Running Away from Big Oil” – precisely the point I’ve been making.
These are just three examples, there are thousands more from companies all over the world. There is much talk of “greenwashing” when these sorts of companies make these sorts of announcements, and there is certainly a fair bit of that to be sure, but the mere fact that they even feel that this is something they need to be doing and that ESG even exists is surely a real improvement on times past?
Companies mirror us after all…
The behaviour of corporate entities will necessarily mirror the society we live in, because everyone involved with those companies come from within that same society. As another example of this sort of thing, only a few days ago, Gallup published an updated poll on the percentage of people in the United States who support same-sex marriage. This number is now 70% - the highest level since the poll began in 1996. This number is up fully 10% since 2015 when the US Supreme Court ruled that all states must recognise same-sex marriage and 43% (!) since 1996 when the poll began. Call me naïve and Pollyannish, but I don’t think it is much of an intellectual leap to believe that discrimination in the workplace based on sexual orientation is likely to be less of an issue when 70% of the population is for same-sex marriage than when that number was 27% as recently as the mid-nineties?
Last October I wrote a piece called “The World is the Best it has Ever Been”. In that piece I suggested that the internet and social media might actually be having a pretty positive affect on the way we conduct ourselves as a species overall, notwithstanding the well-publicised problems that they can cause. For all the problems with things like online bullying and the impact Facebook et al. may or may not be having on elections, and for all the toxic bile that it is very easy to find online, there is a fair amount of evidence that society is becoming more tolerant and enlightened across the board and social media has also been used highly effectively to foster the sort of consumer activism which can improve outcomes when it comes to all things ESG.
Whatever your position may be on movements like Black Lives Matter or Greta Thunberg, those two movements can be far more powerful and exert far more impact on companies (and governments) than in the past, in large part thanks to social media.
I’m not saying that the world is perfect and that every company now behaves extremely well – but I do feel pretty strongly that the direction of travel is pretty encouraging, as I say. The mere fact that ESG even exists and more than €200 billion of investment money flowed into ESG funds in Europe last year is another pretty strong indicator that this is the case.
How ESG are we (Plain English Finance that is)?
I’ve wanted to write a piece about ESG for some time, if only because of just how much press it has had in the investment world in recent years. Another motivation, however, has been the fact that many of our audience have asked us about how ESG our fund is – and, most recently, so has a professional investor who is contemplating a large investment into it.
Their main concern was around the extent to which our fund might have a “carbon” exposure. As a result, the Professors and I did some work on that question and I thought I may as well share our answer, given how many of you have also asked about this over the last few years.
We looked at all the assets that we hold to implement our strategy and the conclusion is that we can certainly claim to have a structurally low carbon exposure: When the fund is fully invested, it will hold 2.5% in energy commodities specifically and the energy / “carbon" component of our equity and bond holdings would average anywhere between just over 1% and about 8.6% - per silo. (Remember that our fund uses large, liquid ETFs to own large markets like the S&P 500 in the US and FTSE in the UK and so on. The point here is that some of those ETFs have "carbon" economy companies that represent about 8.5% of the index and others only about 1%. These estimates come from the factsheets of the respective ETF products).
As a result - this implies that across our entire fund we would estimate our maximum exposure to be around 9.5% - and only when fully invested. The number will be lower where we are more defensively positioned (which is often the case). This number would rise to 12% if you also included gold as a “carbon” investment - which is a matter of opinion.
The broader point, however, is that even within that 9.5% and 12% - the companies we would own are the likes of Shell and Unilever – to reinforce the point I made above about the direction of travel in such things overall. Given that our strategy will only ever own the largest companies in the world – by nature of our approach – I would like to think that even within that c. 9.5% potential exposure we should have very limited exposure to companies that might reasonably be described as properly “bad actors”.
I think that’s it for today. I hope you found the above a vaguely useful explanation of what ESG is all about and, dare I hope, even moderately uplifting.
In my next couple of articles, I intend to cover crypto (finally) and also share some pretty big news about Plain English Finance which I hope will be of real interest to many of our readers.
Until then, I wish you all the very best for your investments and, by extension, for life more generally!