Philosophical Issues Bedeviling Responsible Investing
We’ve reviewed many potential pitfalls that bedevil responsible investing, but now let’s turn to some of the more philosophical issues in the space.
Try to ignore self-interested research in the RI sector.
Almost every day, a financial or consulting firm publishes “research” purporting to show that this or that type of RI produces terrific outcomes. Take this stuff with a very large grain of salt.
We should, instead, always ask ourselves this question: What is the likelihood that this particular firm would publish research showing that RI produces very poor results? If the likelihood is zero, as it usually is, we can safely assume that the research was shoddily designed, impossible to replicate, and undertaken merely to sell RI products or make themselves look good.
Instead, focus on the academic research in the RI space, which is more rigorous and less biased. George Serifeim (Harvard Business School) is especially sound in this area, but there are quite a few others.
Are you focusing on materiality in your RI investing?
Speaking of Professor Serafeim, one of his most important contributions to the RI field is the need to figure out which of the dozens of ESG issues are actually material to a company’s financial performance and which aren’t. Just because we wish that some ESG issue or other would be rewarded in the marketplace doesn’t mean that it actually is. For those issues we should be using our philanthropic dollars, not our investment dollars.
Are the returns on your RI investment caused by the RI characteristics?
All too often it turns out that the good returns touted by RI managers are actually driven by some other, non-RI factor. For example, many of the studies showing a correlation between ESG factors and strong returns are actually saying nothing more than that technology stocks have done well recently.
Since tech stocks won’t always do well, it behooves us to focus on RI factors that are actually causative. As noted above, just because we wish every RI or ESG factor would lead to outperformance doesn’t make it true.
The perfect is the enemy of the good.
Absolutism in the pursuit of doing good with our investment portfolios is a very bad idea: the fact is that we really can never do just one thing.
Companies with great diversity on their boards and management teams might also have lousy carbon footprints. Companies with terrific environmental records might be supporting sweatshops in Vietnam and Cambodia. But we have to invest somewhere.
Consider the example of the Norwegian sovereign wealth fund (the Norwegian Government Pension Fund), which is both the largest and, by a considerable margin, the most respected, sovereign wealth fund in the world. The Fund emphasizes the fact that it is a responsible investor and will not own “bad” companies as variously defined.
But consider, first, that the Fund owns roughly 9,000 companies and has identified only 238 companies as unacceptable. Most of us could come up with several times that many with our eyes closed (most of the Chinese stock market, e.g.).
Or consider this. The Fund receives its money from the vast oil fields in the North Sea off the coast of Norway. Yet most of the companies the Fund won’t own are also in the hydrocarbon business. By divesting coal companies and firms that use coal, the Fund is helping to undermine Norway’s competitors.
Worse, as many environmentalists have pointed out, Norway is essentially saying, “We are delighted to get rich on hydrocarbons, but we want to make sure nobody else does.”
Despite all this, the Norway Fund deserves its reputation as a responsible investor. It engages directly with management teams to advocate for ESG practices and its example has been widely emulated among large investment funds. Like the rest of us, the Fund can never do just one thing, and it recognizes, as we should, too, that the perfect is the enemy of the good.
Don’t be too eager to be a pioneer.
Unless you are a sovereign wealth fund with $1 trillion or so, it’s best to let someone else be a pioneer in the RI space. Investing in novel RI ideas too soon involves taking risks way beyond any measure of prudence.
After the Big Boys and Girls have made the leap, suffered the losses, and finally figured out how to do it, that will be the time for us to jump in.
If it sounds too good to be true, it probably is.
Many people, including former World Bank President Jim Yong Kim and Bill Gates, have argued that foreign aid has failed to lift people in developing countries out of poverty. Instead, they have touted the need for private investors to put their capital to work in places like India, Africa and the MENA region.
This might turn out to be a good idea, but the early returns aren’t impressive. Not only have most of these “impact” private equity funds turned in disappointing returns, but there have been some unconscionable frauds.
In 2016, for example, a relatively obscure private equity group raised a multibillion dollar fund designed “to do good and reap rich private equity-style returns.” Specifically, the Abraaj healthcare fund would acquire and build hospitals in Africa, India and other relatively undeveloped nations, simultaneously bringing health care to remote regions and building valuable assets.
People—especially governments and international development agencies—have been building hospitals in places like Africa for at least seven decades, and no one ever made any money doing it. In fact, vast amounts of money were lost over that period.
Exactly why it was that Abraaj would succeed where others had failed was never clear, but the pitch was emotionally powerful and many otherwise sensible investors—including the Bill and Melinda Gates Foundation—fell for it. In 2018, it all collapsed. The top three executives, including the director of impact investing, have been arrested and charged with fraud, and the fund itself is being dissolved.
In other words, our enthusiasm for helping underserved populations needs to be tempered by our skepticism as sensible investors.
We’ll finish up next week with a few random issues that crop up in the RI space.
Next up: Responsible Investing Without the Hype, Part IV