Or perhaps the beginning of the end......

This newsletter has, since its very inception, been a strong critic of the "ESG" investing approach. In case you have forgotten, "E.S.G" stands for Environmental, Social and Governance and this type of investing refers to a set of (arbitrary) standards used by socially conscious investors to screen their investments.

It has been all the rage for the better part of a decade and wrecked not an insignificant amount of havoc as many professionals investors were pushed by their clients to add ESG criteria to the already exceptionally difficult beating of their benchmark.

You can read some of our earlier work here and here and here.

More recently, here is a 2022 recap of our 2021 arguments.​

Our earliest pieces above date from the second edition of this newsletter - the notorious and now very valuable "Pebble 2." So, this is not a new point from us and we have carefully charted both its rise and now, increasingly, its fall.

Our most recent piece entitled "The ESG King Having No Clothes" also references Stuart Kirk, who has the quote at the start of this newsletter and the fact that he was first suspended and then eventually left the bank, HSBC, for pointing out some of the points that we (and others) have been saying for some time.

As you may recall, we had three big points when it came to the fashion for "ESG" funds:

1. It wasn't green.

2. It was a slick way to get you to pay more fees for, well, not very much.

3. Many of the strategies made you dangerously concentrated in certain sectors and industries without telling you that.

To summarize, an ESG fund was a more expensive and less complete version of an index fund that does little to help the environment.

Not great.

This is not to say that, as we have also argued before, climate change isn't real or that corporations and the financial industry could not do a lot more to help make a greener planet and fund and achieve the critical transition.

There is just a mountain of evidence that the ESG ploy isn't going to achieve a greener planet. And there is increasing evidence that they are a recipe for under- rather than overperformance vs the wider benchmark index. We aren't going to rehash all our arguments from previous work but put simply:

If buying an ESG ETF or mutual fund means you are paying many, many times the "management" fees as buying a simple index and that ETF simply invests you in a overly large allocation into tech that is achieved because the likes of Microsoft are considered "green" because they are a) tech, not oil companies and b) "offset" their emissions by buying assets like forests.

That process makes little sense on its face (our society needs mining companies, and natural gas companies, not just tech firms?) and even less when those forests burn down, as they did over the last few summers. What happens to your ESG rating then? What counts more? A greener planet or simply a green rated portfolio?

The level of amateurism and foolishness is stunning, especially, once again when you take the fees into account.

Today, there is good news on the ESG front. There might even be good news for the planet as well. The good news of the former is that the fad around ESG being the silver bullet for climate change may be finally falling out of fashion and not just on these pages.

This can be seen in cold hard data with the rapidly diminishing inflows into ESG funds:

This wasn't all though. It gets better.

This week the head of Vanguard, Tim Buckley, gave an interview to the Financial Times where he poured cold water all over some of the deepest held ESG orthodoxies.

In the main, the CEO argued that:

“Our research indicates that ESG investing does not have any advantage over broad-based investing."

Hear, hear.

Vanguard isn't unimportant either. It is one of America's largest asset managers and also its most committed to offering cheap and passive index investing of the style that we are deeply passionate about as well.

It was founded by John C. Bogle, who invented the low cost index fund and was fired, ridiculed and attacked as "un-American" for his trouble. He got the last laugh though: Bogle died a billionaire and a legend and is so revered that he has a whole class of adherents who call themselves the "Bogleheads."

It is truly an American story. You can read more about him here.

We digress though, Buckley continued:

“It would be hubris to presume we know the right strategy for the thousands of companies that Vanguard invests in. We just want to make sure that the risks are being appropriately disclosed, and that every company is playing by the rules.”

Indeed. We couldn't have said it better ourselves.

He didn't stop there either: in a stunning break from tradition, the finance chief backed up his rhetoric with action. Vanguard has left the $59 trillion Net Zero Asset Managers Initiative, a group that is part of the $150 trillion United Nations-affiliated Glasgow Financial Alliance for Net Zero.

In taking this course of action, Vanguard was making a simple and often forgotten point:

• As an asset manager, they have a fiduciary duty to their clients.

This is a legal responsibility to act in the best interests of your client. When you are in a financial sense. This is both a serious matter and a difficult one. There are plenty of very tough decisions and tensions to resolve but deciding to optimize a client's portfolio around another set of potentially competing criteria was likely never one of them.

The very real costs of such conflicting goals have been laid out this year as the over-allocation to technology (and excluding energy stocks) has cost nearly all ESG strategies a huge amount of investment performance and produced for their clients a terrible year before we get to the additional and unspoken fees involved.

See here:

*Yeesh*

And so after reflection it is both unsurprising and commendable that Vanguard have stated that they cannot, in good conscience, muddy those responsibilities with a conflicting set of climate priorities. You are either prioritizing investment performance and being a good fiduciary or you are not and you need to be honest about that fact.

There is no saving the planet AND outperforming )or even just matching) the stock market index at the same time. Each discrete goal is incredibly difficult all by its lonesome, adding them together makes it an impossibility. Even writing those words is laughable.

It is equally important to remember that it is far from clear that the ESG approach is beneficial for the climate either. It is highly ironic and very telling that other asset managers have been:

• Criticizing Vanguard for turning their back on ESG.

• And at the same time warning in their quarterly earnings call that their profits will likely be hit as the growing criticisms and backlash against ESG gathers steam.

Good riddance.

The fact that these asset managers make MORE money with ESG than regular investing is the clinching argument that this was always far more a marketing hustle than a serious effort to bring environmental policy to investing.

In fact, we have long argued that this paradigm achieves the exact opposite by pretending that something serious is being achieved. It allows governments to pass the buck to companies and investors with the hope that by magically deferring the responsibility to tackle the many, many difficult decisions and tradeoffs involved in combating global warming.

The Vanguard CEO touches on this point as well:

"Politicians and regulators have a central role to play in setting the ground rules to achieve a just transition.”

i.e.: this isn't our job and in trying to make it ours, you actually damage our core (legal) responsibility.

There are, however, some better strategies out there. Some are being tested and others might even be succeeding. This is the other good news.

For example, the EU’s carbon price has climbed above €100 a tonne for the first time.

See here:

This was a landmark moment for European bloc as well as the world's efforts to combat climate change and build a working set of incentives to sensibly manage the transition to net zero.

This publication isn't frequently complimentary of Europe and this might be the especially the case when it comes to innovation and financial innovation at that.

However, we are thrilled to change tack and compliment our European cousins with building a working carbon market and one that is lighting the way forward not just for America but around the world.

The carbon market had lots of problems initially (prices were set too low and many credits were handed out too easily among other issues etc.) but over time those mistakes have been corrected or simply fallen by the wayside and the progress is now notable.

There is now a working carbon exchange and incentive system in Europe. One you adequately start pricing carbon, albeit imperfectly, you can effectively discourage its consumption.

So, in conclusion, these are some big steps. Acknowledging that the ESG paradigm is flawed is a critical step. Perhaps with significant work, this flawed paradigm can be fixed. Some argue for that scenario but ideally it would simply be discarded in favor of something like the European carbon trading scheme but on a global scale.

That might be impossible right now but there is no reason that the US cannot build its own system and it would be better to devote our considerable new world energy and towards that than an empty marketing construct like ESG.

So, overall, this has been very positive news. Moving beyond the contradictions, arbitrariness and emptiness of ESG is likely a necessary requirement to properly containing climate change and having the important investment industry taking a leading role in that effort.

The latter is not just possible but very likely. Some of the most aggressive hedge funds have been entering the carbon credit market not out of any sense of climate altruism but rather because it is both a real market and one they think they can do well in versus sleepy state owned utilities and industrial behemoths. That type of incentive is a good thing as it demonstrates that we can use some of the least positive human traits to achieve a more efficient and positive outcome, if we structure things correctly.

There is likely no hope for ESG but there is hope for the battle against climate change and for the financial industry to play a positive role in that struggle.

Other markets are less vibrant and alive however....they might be frozen.

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Have questions? Care to find out more? Feel free to reach out at contact@pebble.finance or join our Slack community to meet more like-minded individuals and see what we are talking about today. All are welcome.