Good intentions don’t count in RI
There are lots of areas of human endeavor where good intentions matter a lot, but RI isn’t one of them. In RI, good intentions, if not married to serious diligence, can make the world not a better place but a much worse place.
Consider the hideous disaster of the switch to biofuels for vehicles. When US legislation mandated the mixing into diesel and gasoline of vegetable oils, the EPA estimated the gains would be huge: equivalent to parking every American car for seven years. Other Western nations soon followed the US example.
The result was a gigantic surge in demand for vegetable oil, a demand that couldn’t begin to met by American farmers – not if Americans also wanted to eat. Thus, giant palm oil plantations were built in places like Indonesia.
Unfortunately, the Indonesian jungles, and especially the vast peat bogs in Borneo, contain huge amounts of carbon. When those jungles were slashed-and-burned for the palm plantations required to meet surging global demand for vegetable oil, enormous volumes of carbon were released into the atmosphere.
An article in the journal “Science” estimated that the switch to ethanol had doubled the volume of greenhouse gas emissions in the atmosphere. Eventually, the EPA itself concluded grimly, it would take a century (!) for the benefits of ethanol to overcome the initial carbon explosion and finally begin to reduce carbon emissions.
Before we invest in projects that promise to transform the world, we need to be sure the world will be transformed for the better.
Should it bother us that RI investing is an elite activity?
It’s no secret that American society is bitterly divided between a prosperous elite and a far larger group of people who haven’t fared well under three decades of globalism. And that disconnect is mirrored in people’s views of RI investing.
I noted in the first paragraphs of this series of blogs that vast amounts of capital are now pursuing RI mandates. But virtually all that capital is being invested by large, elite investors: sovereign wealth funds, large endowments and foundations, ultra-wealthy families.
This enthusiasm isn’t shared by the rest of America. For example, a YouGov survey in 2017 showed that, when it came to their pensions, only 13% of millennials wanted to be invested ethically, and only 6% of older people cared about ethical investing.
Or consider what recently happened at CalPERS, the huge pension plan for California’s public employees. CalPERS’ president, Priya Mathur, was the driving force behind the pension plan’s move into ESG investing. But in 2018, Ms. Mathur was decisively defeated (by vote of the government workers who benefit from the pension plan) by Jason Perez, who opposed ESG and who claimed that CalPERS was being “used more as a political-action committee than a retirement fund.”
It’s useful to keep the “sin stock” phenomenon in mind
Sometimes, RI investors can become so confident in their ESG theses – especially after a period of outperformance – that we become cocky. We not only own the ethical high ground, we come to believe, but we also outperform traditional, non-ESG investors.
This hubristic mindset will lead nowhere good, and one way to counter it is to keep firmly in mind the fact the sin stocks – companies involved in alcohol, tobacco, gambling, weapons, and so on – have substantially outperformed other stocks, including ESG stocks, for many decades.
No one is entirely sure why sin stocks do so well, but it likely has to do with a) pricing inefficiency, as many investors simply won’t own them, b) the “profitability” effect (sin companies are usually extremely profitable), and c) the “size effect:” as a result of hostile regulatory and litigation environments, sin stocks can’t, in effect, outgrow their outsized profitability.
But the obvious point is this: whether or not it is true that companies that do good will do well (and the truth is that the jury is still out on that point), it is undeniably true that companies that by their very nature do bad have done very well. This fact might serve to leaven our presumption.
Beware of late-life conversions to RI by billionaires
Virtue signaling occurs when a person, company or investment manager conspicuously touts their commitment to (in this case) RI, when the gesture is essentially empty and is designed only to make the speaker look good.
An especially annoying example of virtue-signaling occurs among aging-but-famous financial types who suddenly develop a keen interest in RI. Usually, this sudden conversion is designed to burnish their reputations and seal their legacies, rather than deliver good returns.
A spectacular example of this phenomenon occurred about a decade ago when a famous venture capitalist gave a tearful TED talk about the dangers of climate change. The famous VC’s venture firm had, not so coincidentally, recently launched a clean-tech fund.
This VC and his partners had become billionaires by investing in hundreds of firms over the years that polluted the globe, treated workers and communities abominably, and boasted appalling governance structures. Now, suddenly, he was a born-again RIer.
The trouble was that neither the famous VC guy nor any of his partners knew anything about clean tech and the fund was a disaster. Indeed, one of the investments, Fisker, posted the biggest loss in venture capital history. The tearful TED talker resigned his position at the VC firm, but that was little solace to his investors.
But it’s actually worse than that. So bad were the results of the early clean-tech funds that even today, years later, RI venture funds have serious trouble raising money. As a recent New York Times article put it, “Everyone … points back to the clean-tech boom, when … most of the clean-tech funds were viewed as failures.”
So the next time a famous-but-aging billionaire suddenly develops a keen interest in RI, take your money and run the other way.
Next up: Abbott Sekaquaptewa