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Good morning. Those of you who have read too many of my anti-ESG screeds already may want to skip this letter. But I have no plans to shut up on this topic. We’ve got big global problems. I am a capitalist red in tooth and claw, but I just can’t see how financial markets have a meaningful part to play in solving these problems until citizens and governments act first and decisively.

Email me and tell me why I am wrong:

Tariq Fancy is right about the ESG investment industry

Almost everything that Tariq Fancy says about environmental, social and corporate governance, or ESG, investing has been said before, in one form or another. The significance of what he writes — most recently in a long essay on Medium — is how he says it and who he is. He was the chief investment officer for sustainable investing at BlackRock, which is the most important institutional face of the claim that ESG investing has an important role to play in helping the environment, promoting the social good, holding the corporate world accountable, and so on. 

Fancy thinks the ESG project is intellectually bankrupt and is damaging to the most important causes it purports to support. I think this too (at least the “E” and “S” parts; there may be hope for “G”), but it means a lot more coming from him, and he does not hold back. He says BlackRock’s position on global warming is analogous to the National Rifle Association’s on US gun deaths:

In my role at BlackRock, I was helping to popularise an idea that the answer to a sustainable future runs through ESG and sustainability and green products, or in other words, that the answer to the market’s failure to serve the long-term public interest is, of course, more market. A bit like the NRA’s traditional answer to mass shootings and related concerns around public safety — the answer is more guns.

He says, furthermore, that the senior executives he used to work with are way too smart to believe their own claims about ESG:

They must know that they’re exaggerating the degree of overlap between purpose and profit . . . These leaders must know that there is no way the set of ideas they’ve proposed are even close to being up to the challenge of solving the runaway long-term problems . . . And right now all of the other stuff they’re saying — the marketing gobbledegook — is actively misleading people.

I urge you to read Fancy’s essay, which is full of powerful and darkly funny anecdotes about high finance. But because he touches on so many of the key arguments against the ESG industrial complex, it’s a good excuse to lay them out. 

Argument one. The only really coherent case for ESG investing changing the world is that it raises the cost of capital for “bad” companies (however you or your fund manager want to define “bad”), which means they have incrementally less financing to do bad stuff. But this argument does not get much airtime from investment companies, because it does not sell high-fee financial products. It is too technical and cuts directly against the idea that ESG investors will make superior returns, in addition to doing good. When Fancy made the cost of capital argument to another BlackRock exec about a low-carbon fund, here’s what happened:

“But didn’t you see the talking points?” insisted [the exec], referring to a set of oversimplified bullet points I had not seen arrive in my inbox of overflowing and unread emails the day before. They made clear their view: the key to selling the product was to keep it simple, even if that meant glossing over how it directly contributed to fighting climate change.

Argument two. If ESG investing did provide higher returns — as the industry both explicitly and implicitly promises — then profit-seeking investment managers would be doing all the work for us, and we wouldn’t have to be having this damn conversation in the first place.

In one chat with a portfolio manager of stocks, I noticed that his subtle dismissal of the latest research declaring ESG-data-is a-godsend! had a “thou doth protest too much” air to it. It wasn’t hard to guess why . . . The portfolio manager’s view was that they’re already focused on performance since it usually determines their compensation, so if ESG information was truly useful they’d use it without being asked

Argument three. There is no good reason to think that the investment horizon of companies and investors should approximate the timescales of the big collective problems we face. For this and other reasons, the overlap between purpose and profit is small.

Most of what the ESG cheerleaders [at BlackRock] wanted to believe should matter for portfolio managers did not matter in reality. It was no one’s fault: the reality is that much of what matters to society simply doesn’t affect the returns of a particular investment strategy. Often this is because of the timeline of the underlying investment: many strategies have a very short time horizon, meaning that longer-term ESG issues aren’t particularly relevant.

Argument four. The core mechanism of ESG investing is divestment, but when an investor sells a security in the secondary market, another buys. All the ESG selling may drive down the price at which the buyers buy, giving them an opportunity for juicy returns as the price recovers.

There’s a difference between excusing yourself of something you do not wish to partake in and actively fighting against something you think needs to stop for everyone’s sake. Divestment, which often seems to get confused with boycotts, has no clear real-world impact since 10 per cent of the market not buying your stock is not the same as 10 per cent of your customers not buying your product . . . The first likely makes no difference at all since others will happily own it and will bid it up to fair value in the process.

Argument five. Giving people the dumb idea that shifting their savings from one investment fund to another is going to help materially with, say, climate change creates a dangerous distraction from solutions that fit the scale of the problem, all of which involve changing the rules of capitalism through regulation. 

Working with academics and a polling firm, Fancy polled 3,000 people, showing them headlines about ESG risks in the financial system, and asked respondents whether the headlines described an idea useful in the fight against climate change. One headline was about efforts to protect portfolios from climate risk. 

I suspected that every time people read the latest such headline about guarding against climate change-related risks in the financial system, they mistakenly believed that these efforts were helpful in the fight against climate change itself. In fact, the survey found that not only was that true, but that most people think that this kind of work is just as helpful as any other pledge, such as large-scale organisational commitments to become net zero carbon emitters. Unfortunately, protecting an investment portfolio from the disastrous effects of climate change is not the same thing as preventing those disastrous effects from occurring in the first place.

Argument six. Green bonds open the way for a neat little capital arbitrage by companies and governments.

It’s not totally clear if [green bonds] create much positive environmental impact . . . since most companies have a few qualifying green initiatives that they can raise green bonds to specifically fund while not increasing or altering their overall plans. And nothing stops them from pursuing decidedly non-green activities with their other sources of funding.

Argument seven. To really change the relative financial calculus for “bad” versus “good” companies, ESG funds would have to be orders of magnitude bigger than they are now. They are not going to get big enough. 

[Is] a $2bn fund enough to make a difference if the majority of the global economy, with nearly $6tn in private equity alone and some $360tn of global wealth overall (3,000 times and 180,000 times larger, respectively), continue operating business as usual? 

Argument eight. Corporations, and the whole legal and social apparatus in which they sit, were built around the idea that companies exist to maximise shareholder wealth. That’s what they are designed to do and are required to do. Thinking that fiddling around in the financial markets is going to make companies fit for a radically different purpose — helping with broad social problems driven by economic externalities and tricky collective action problems — is simply bonkers. 

From top to bottom, from CEO compensation to divisional budgeting and P&L to managerial targets, structures and incentives, we’ve built private firms from the ground up to do one thing really well: extract profits . . .

. . . The vast majority of large US companies are incorporated in Delaware, which is perceived as shareholder-friendly and where the courts have been clear that a corporation’s reason for existence is to serve shareholders . . . The foundation of capitalism is strict adherence to fiduciary obligation . . . This adherence to fiduciary obligation “gives credibility to capitalism by addressing the agency cost risk of entrusting money to others”.

Argument nine. Do you really want financial industry bigwigs making choices about how to solve our biggest social problems? Fancy quotes one of the signatories to the hilariously empty and meaningless 2019 Business Roundtable statement on the purpose of the corporation:

“There were times that I felt like Thomas Jefferson.” So said Johnson & Johnson CEO Alex Gorsky, who led the drafting of the BRT’s groundbreaking statement on stakeholder value. It’s easy to understand why he felt that way, given the weight of such lofty words about the future direction of not just business, but indeed society in general. But not enough people have asked a simple question: does it make sense that a CEO should feel like a famous US president? Only one of them is elected by the people

I myself find argument five particularly important. From what I understand, it’s clear we need, for example, a whopping big carbon tax, and soon, or we’re cooked. But we have some of the smartest, most powerful people in the corporate world rattling on about this sustainable investing drivel instead. It scares me.

One good read 

The Belarusian defector and Olympic sprinter Krystsina Tsimanouskaya is very brave.

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