The End Of ESG?

What became of E.S.G. investing? The idea that investors could - and likely should - take into account Environmental, Social and Governance factors when it comes to allocating capital.

The idea made a lot of sense: life isn't just about profits, and so why should your portfolio? This line of thinking was very seductive. It opened up a perennial human vulnerability of wanting to get a free lunch: in this case help the planet and society, while also making stock market gains.

You can see why it was so beguiling.

Things have changed however.

Larry Fink, the CEO of Blackrock and one of the greatest proponents of the ESG concept, recently came out and said he would no longer use the term "ESG" as it has been "entirely weaponized."

We would be interested to hear why Mr Fink thinks that it happened but regardless, he likely isn't wrong.

Something is clearly happening to the concept that was near universally branded as both morally good and a smart investment idea as little as a few years ago.

Two broad trends are happening right now:

• The first is that ESG funds are losing assets hand over fist.

• The second is that some of ESG's inconsistencies and perhaps even hypocrisies are starting to become not just apparent but glaring.

We have been warning about the second point for some time but the consequences are now filtering into the first. People are realizing that, despite the marketing to the contrary, there are both added costs and consequences of an ESG approach. That doesn't make it wrong but it does make it real. Money has a nasty habit of making reality hit hard, no matter how you want to pretend otherwise.

These ESG struggles both notable and also potentially an issue for those invested in some of these specialist funds. The funds may not suffer directly because of outflows but the underlying businesses can, whether they be index builders or active managers with an ESG bent.
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Let us look at the numbers: Clients have withdrawn a net $40 billion from environmental, social and governance (ESG) equity funds this year, according to data from EPFR that tracks fund flows. This has been the first year that flows have trended negative but 2023 was also rocky.

The outflows are also growing. Redemptions, which include a record monthly net outflow of about $14 billions in April, are also geographically distributed, In other words, this isn't *just* a red state thing.

One of the reasons for this turn might be the very real problems that riddle the industry and these investments.

You don't need to look very far to find them either.

S&P Global published its latest ESG ratings this week and some of the scores were....interesting.

​Tesla the electric vehicle behemoth that paved a path to electrification of passenger vehicles and dragged legacy car brands into belatedly realizing they could drop the internal combustion engine was rated a 40 out of 100.​

That may seem neither here nor there until you realize that Exxon Mobile, a fossil fuel company that steadfastly refuses to pivot to renewables, is rated a 41.​

Yes, a higher score is better.....

​Chevron is also a 41 and Shell is a 45 likely because they are shifting more to renewables, maybe. That is great but Tesla has completely altered how we conceive about personal transportation and has set a pace that every other car company is struggling to match globally.

There are legitimate criticisms of the company but when Altria, the maker of Marlboro, is rated a 43 and Phillip Morris tobacco is an 85 (!!) then something has gone dangerously wrong with this entire concept.

We are sure the good folks at PMI are working hard to make tobacco products safer but.....

Don't believe us? You can play around right here.

That's right someone bright at S&P decided to make it all public. We are a big fan of transparency in general and especially in the retail investing world which for far too long has been both obscure and full of information asymmetries that haven't served regular people whatsoever.

But we are unsure that S&P is helping market ESG here. Or even just sustainable investing. To the contrary they may be underlining why it is, in fact, pretty useless in its current form.

This is what they call in the industry a "tough look."

You likely don't have to be a financial professional or some environmental wizard or social justice activist wizard to get that Exxon being higher rated than, say, a Tesla is hard to square with most people's idea of ESG or even just common sense.

Is it any wonder that, in combination with poor returns that capital has been fleeing the ESG complex?

The wider financial industry has to do better. It may have started with worthy aims and great goals but this has gone from being an inconsistent and possibly self-serving idea to a complete mess. Unless major changes occur it is now at risk of becoming a farce. That will be tough to recover from period, which would likely hurt many things, possibly even the planet.

The good news is the people are voting with their dollars and an industry that has not rewarded investors is in serious trouble. No doubt there will be furious rebrands and an attempt by some people to try and save products that come with welcome and suspiciously high fees but we doubt it will work.

Will ESG exist in a decade? Maybe. Will it matter? No, it won't.

And not a minute too soon. There was a time when we were dangerously close not just to offering ESG products to 401ks but possibly making them mandatory or at least a part of larger, blended products.

That was always a huge, huge mistake. Just because something is wrapped in a morally virtuous goal does not make it any less of a blunder if you haven't carefully thought out how to be a good fiduciary first and foremost.

Thinking very carefully and very conservatively about how you encourage regular people to save and invest is critical. Otherwise the entire investing industry risks losing the trust of people it relies on. And it is not as if there are not (good) reasons to already be suspicious about the motivations and actions of many (though certainly not all) those working in the investing industry.

Sustainable investing will continue and it should. There are both people determined to invest in line with their morals and many of them are fine either costing themselves returns (or higher fees, which is a huge part of the problem here) in pursuit of those goals.

But we are very thrilled that "ESG investing" is no longer on the march to taking over all or even a large portion of passive and retirement investing. It was always a huge mistake as the "actually Tesla is a worse ESG rated company than Exxon" insanity helpfully makes clear.

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