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ESG sucks. In this podcast we’re going to talk about why ESG is a rip-off and nothing more than a way for Wall Street to earn higher fees off unsuspecting people who mean well. Don’t let your clients get taken! Listen to this show.
In this podcast we are going to expose the truth about ESG investing. I am joined by Eric Balchunas who is a Senior ETF Analyst at Bloomberg and the author of “The Bogle Effect.” And also Dr. Ellen Quigley, Special Adviser to the Chief Financial Officer (Responsible Investment), University of Cambridge and Senior Research Associate (Climate Risk & Sustainable Finance), Centre for the Study of Existential Risk, University of Cambridge.
For those of you who are new to my blog/podcast, my name is Sara. I am a CFA® charterholder and I used to be a financial advisor. I have a weekly newsletter in which I talk about financial advisor lead generation topics which is best described as “fun and irreverent.” So please subscribe!
Before we get into it, let’s start with some basic definitions:
ESG: ESG stands for “Environmental, Social, and Governance” and it’s a style of investing that purports (but does not, in reality) save the world from its evils. Governance is an unhelpful tack on, according to Dr. Quigley, usually viewed as unrelated to the first two related to things like board composition etc.
SRI: Socially Responsible Investing. This is a restrictive type of investing that aims to avoid directing funds into sin investments such as tobacco, etc., through use of screens.
Impact investing: A private investment in a company, made in the spirit of saving the world.
Brown stocks (also called “dirty” or “fossil”) vs. Green stocks. A pure play fossil fuel company would be brown whereas a pure play wind turbine company would be viewed as green.
Reasons why ESG sucks
The following are reasons why we believe that ESG is a bad investment strategy.
1. It’s active investing done badly.
By excluding certain types of stocks, you make it more likely you’ll underperform.
According to an article by Larry Swedroe from 2016, controversial investments yield post abnormal returns, generally, and screening them out causes performance to suffer. Swedroe cites a study by Greg Richey from the Summer 2016 issue of The Journal of Investing. Richey’s research found that found a “Vice Fund” produced a greater risk-adjusted return over the market portfolio (Richey, 2016, as per Swedroe, 2016).
With all the moral propaganda and pulling on the heart strings, it’s easy to overlook that ESG, at its core, is an active management strategy that comes, generally, with higher fees (we’ll get to that later) with performance that doesn’t justify them.
It’s the concept of “slactivism”, according to Balchunas: you want to do something good, but you don’t want to exert too much of an effort.
Dr. Quigley says that it’s like rearranging deck chairs on the Titanic, because if you look at the effect that climate change will have on your portfolio overall in the long term, it dwarfs the impact of higher fees anyways, whether or not ESG investing actually works.
2. Secondary market trading doesn’t really impact the company.
The idea that market participants can voluntarily change overarching global problems by the force of their market behavior is a flawed premise that sounds good but doesn’t hold up.
These are key points that many financial advisors do not understand.
First of all, Secondary market trading doesn’t really impact the company. It’s just exchange of shares. Your money goes to a different shareholder. It does not go to Apple’s checking account.
Secondly, The ”bad companies” who are the offenders already have enough capital. They aren’t issuing shares to fund their operations. In fact, they are probably net buyers of shares. The giant companies are sitting on massive cash piles; Apple is sitting on 202bb in cash. According to Yardeni Research, there was $200B of buybacks in Q2 2022 for S&P stocks (which boosts the price).
And guess what else!
The massive cash pile held by just 13 companies accounts for nearly 40% of the $2.7 trillion held by all of the companies in the S&P 500. S&P 500 companies now have enough cash to give $8,131 to every man, woman and child in the U.S.
-Investor’s Business Daily, February 3, 2022
Third, share prices dropping doesn’t tick off the executives who hold large amounts of company stock because often their compensation is determined by the number, not price, of shares. If the company were to become delisted from an exchange, or if they are voted out by proxy, the directors may become embarrassed, fear of which may be a bigger motivator of good behavior.
Lastly, markets are competitive and there are certain types of investors who will look at a company with good cash flow selling at a depressed price and buy shares on fundamentals, even if it is a moral offender. The price will rebound. It takes an unrealistic amount of divestment to have a real effect on a company.
According to Dr. Quigley, 90% of capital raising happens through the bond market. That is where the money flowing into fossil fuels comes from. If you are going to have exclusions, the bond side is much more likely to have an effect. Bond issuances, not secondary market trading in public equities, would have an effect. Public traded equity is not new money, unlike bond issuances.
3. ESG signaling and wokeness are destroying corporate America.
Here’s why I hate ESG ratings.
It’s unclear who the good and bad stocks are because ESG scores are just meaningless signaling. There’s no universal meaning. The ratings are assigned by different companies in a way that is too different. It’s not like in the corporate bond market where we have Fitch, Moody’s, and S&P ratings agencies. There is a huge disparity from one to the next in ESG scores. Two examples of companies who assign ESG scores are SASB and Refinitiv.
Also, ESG scoring is nothing more than a funding tool. Companies have to signal that they are “woke” and consistent with progressive values in order to get funding. It’s more an indication of what your CEO tweets about than the actual virtue or vice of the company’s behavior.
This lack of fairness, transparency, objectivity and the ideology the enshrines the offering up of stock market competitiveness as a sacrificial cow of wokeness is yet another reason why ESG sucks.
4. ESG fees are Wall Street ripping off the consumer
Yet another reason why ESG investing is a bad idea – the fees!
Plain old index funds suck for Wall Street because they decimate the fees they get. But by sneaking in active management in the form of ESG, Wall Street gets another crack at shaving off a higher level of fees from the unsuspecting consumer.
Research shows that ESG comes with higher fees, so much so that it may be better to take fee savings and donate it to a charity that has impact than actually invest in an ESG fund and pay the higher fees.
From a Wall Street Journal Article:
The environmental, social, and governance funds’ average fee was 0.2% at the end of 2020, while standard ETFs that invest in U.S. large-cap stocks had a 0.14% fee on average.
-Wursthorn, 2021, as per Sullivan, 2021
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Krantz, Matt. (9 February, 2022) Investor’s Business Daily. 13 Firms Hoard $1 Trillion In Cash (We’re Looking At You Big Tech). https://www.investors.com/etfs-and-funds/sectors/sp500-companies-stockpile-1-trillion-cash-investors-want-it/
Richey, Greg. (2016, May). Sin Is In: An Alternative to Socially Responsible Investing.? Journal of Investing, 25(2):136-143. DOI:10.3905/joi.2016.25.2.136. https://www.researchgate.net/publication/303634950_Sin_Is_In_An_Alternative_to_Socially_Responsible_Investing
Sullivan, John. (2021, March 16). 401k Specialist. Sustainable Scam: Is ESG About Responsibility or Higher Fees. https://401kspecialistmag.com/sustainable-scam-is-esg-about-responsibility-or-higher-fees/
Swedroe, Larry. (2016, July 25). ETF.com. Swedroe: Costs Of Socially Responsible Investing. https://www.etf.com/sections/index-investor-corner/swedroe-costs-socially-responsible-investing
Wursthorn, Michael, (2021). Wall Street Journal. Tidal Wave of ESG Funds Brings Profit to Wall Street https://www.wsj.com/articles/tidal-wave-of-esg-funds-brings-profit-to-wall-street-11615887004
Yardeni, Dr. Edward, Abbott, Joe, Quintana, Mali. (9 December, 2022). Yardeni Research. Corporate Finance Briefing: S&P 500 Buybacks & Dividends. Figure 3: Buybacks & Dividends. https://www.yardeni.com/pub/buybackdiv.pdf
0:00:01.0 : ESG, get the beeeeep out of here. ESG sucks. In this podcast, I am joined by Erik Balchunas, who is a senior ETF analyst at Bloomberg and the author of The Boggle Effect. Dr. Ellen Quigley is a special advisor to the Chief Financial Officer of Responsible Investment at University of Cambridge. She is also a senior research associate in climate risk and sustainable finance at the Center for the Study of Existential Risk at the University of Cambridge. We’re going to talk about why ESG is nothing more than a way for Wall Street to earn higher fees off of unsuspecting people who mean well. Don’t get taken, folks. Listen to this show. Welcome, Erik and Ellen. Thanks so much, Sarah. Great to be here. Great to be here. So what we’re going to do is I’ll list out the reasons I think ESG sucks and then after each one you tell me if you agree or disagree. If I’m tripping or whatever. Sound good, folks? All right. So before we get into it, let’s just start with some basic definitions because one of the things, first of all, that really annoys me about ESG is how some people, even people who are supposed to be the credible authorities, misuse the terminology in this field.
0:01:15.9 : So first of all, ESG, what does each letter stand for? Who wants to take it? Environmental, social, and governance. Okay. And so I think people understand the E and the S a lot, but what is the G part actually? It’s an unhelpful tack on. Usually viewed as unrelated to the first two, but it’s meant to address things like board composition and so on and so forth. Okay. I can tell you’re not a big fan of this. This is going to be good. I’m going to get into it. Okay. Another term that people often blend with ESG is SRI. Now this is way back. I remember, it must have been over a decade ago, Amy Domini with Domini Investments was one of the first kind of socially responsible investors. So SRI stands for socially responsible investing. Is it ESG? It’s useless in many of the same ways, but probably with much more sincere intentions behind it. Well, socially responsible investing aims to eliminate the sinners. So, you know, gun stocks, nukes, whatever. So it’s a restrictive form of investing and it is a part of ESG, but people kind of use it interchangeably and it’s not. Okay.
0:02:34.8 : ESG is not all involving restricting from the bad investments. ESG also aims to promote supposedly the goal of ESG is to promote the growth of companies that are supportive of beneficial practices, which is debatable and we’re going to get to that. Impact investing. Okay. So impact investing is, well, in some cases it refers to making private investments or investments in private companies, but it’s the idea of promoting companies that aim to do good in the world or have an impact. Brown versus green stocks. Could we say dirty or fossil instead of brown? Sure. Yes, exactly. This is something that people just throw around. So what’s the distinction there, Ellen? I mean, it’s going to sound a bit artificial, but yeah, so like a pure play fossil fuel company would probably count as a dirty or fossil fuel stock, whereas a pure play wind turbine company would be viewed as green.
0:03:36.1 : Okay. And right there, I think, you know, the idea of, okay, well, first of all, my take on impact is I’m probably the most optimistic there. I don’t know how Ellen feels, but impact is, okay, let me buy wind turbine companies or solar energy companies. And in the ETF side, those ETFs would be like tan, which is like 20 solar stocks. It’s a pretty clean situation or communication. Hey, I want to put my money into some things that where people get up every day and try to like get something done on this thing. That’s just the E by the way, it’s not the S and the G, but that kind of makes sense to me. I’m going to put my money towards this and try to have an impact. So when you talk about those companies, that kind of play also typically fits in a portfolio where you might have like a couple of cheap index funds or your 401k account. You could just tack that on. You know, 7, 8% or even less. And now you are sort of long these stocks or companies that are doing this thing that is good for the environment or what have you.
0:04:48.1 : I’m sure we’re going to get to the ESG and SRI where you exclude companies, but I kind of get impact investing. To me, that makes sense. I think people sometimes confuse that when Tesla was kicked out of the S&P 500 ESG index, people were like, what? It’s a clearly, it’s literally an EV company, but people, again, they confuse what the company does with their ESG scores. Whereas impact, I think is a little clearer. What this company does is part of the impact. And I just seems like it’s the communication there at least is pretty clear. I don’t know if you guys disagree, but impact to me makes the most sense.
0:05:28.2 : I think we do disagree on a couple of things, Eric, which is good because it’ll keep Sarah’s podcast interesting, but I would not consider a renewables ETF an impact investing and would, it’s pretty much useless to select that versus something else because it’s secondary marketing. Okay. But let’s go through that. Like, so if you buy 20 solar stocks, why is that useless?
0:05:52.0 : Because there’s no additionality base, not, not, no, there is such a tiny, tiny amount of additionality that it’s basically, it’s, it’s basically no additionality. So it’s secondary market. It doesn’t affect the company. You’re buying and selling between and among investors. The money doesn’t go back to the company. I’ve reviewed all of the studies on this. Basically, it’s hard to find any real impact from that.
0:06:14.3 : What about if you just think that’s a, an industry that will, will grow?
0:06:21.8 : Sure. But then you’re not having an impact.
0:06:23.8 : Okay. All right. All right. Fair enough. Maybe I’m confusing the fact that impact has to be private. Does it have to be in the private markets?
0:06:33.3 : Sarah, feel free to, I know I have to say the whole thing about it. I think it has to be in debt or, or private markets because that it has to be a primary market transaction.
0:06:45.6 : Yeah. Right. Okay. I mean, let’s face it though. I mean, enough public market interest could push the envelope on some of these things, but if, if my little account buys tan, I, yeah, it’s not going to really move the envelope. Even at high. Yeah. No, like honestly, it’s, it’s secondary market is not where we want to have impact even at fairly high levels of involvement on the part of very large investors. So, okay.
0:07:12.0 : Let’s just say we, okay. I still get impact investing if it’s private, right? I’m not saying I don’t, I think what I will then switch my terminology, I’ll call tan a thematic ETF that happens to be in the sort of environmental realm. And I, I like those. I mean, I, I, again, I’m kind of with you. How much good does it do? How much good does it do? But for me, I’m looking at portfolios all day and I, to me, there is a, you could see the practical purpose. I mean, let’s just say, is there any purpose at all to owning a solar company?
0:07:48.7 : I mean, yes, but I mean, yeah, we could, this is a whole conversation. It’s just that like owning a listed solar company, owning the shares of it doesn’t help or hurt that solar company on average.
0:08:02.8 : Right. And I think this is where we get into the ESG and which is a bigger that, you know, ESG wants to sort of be your core, right? Wants to be, hey, sell all your index funds and buy this ESG strategy. And then the question is how much does that actually impact these companies? I would assume you’re of the no, because now we’re talking the same deal. It’s all secondary market. It’s all publicly traded companies. I’m going to value this one and take this one out, tweak this, do that. And I’ve got my ESG. I’m going to sleep at night. And that’s, that’s largely BS.
0:08:39.6 : Yeah. It’s rearranging deck chairs on the Titanic.
0:08:43.4 : Yeah. This is what the BlackRock X sustainability person came out and basically said, not only is it not doing anything, it’s actually bad because it’s giving people a false sense of I’m doing something.
0:08:55.8 : I really agree with Tariq on this. He’s technically right. So what I have about five reasons that ESG sucks. And one of the reasons is, and folks tell me if you agree or not with this, is that it’s active investing done badly. And the reason is that by excluding stocks, you’ll make it more likely that you’ll underperform. According to Larry Swedro, quote, controversial investments generally yield positive abnormal or risk adjusted returns using the Carhartt, Carhartt four factor model, which is beta size value and momentum. Screening them out produces suboptimal financial performance. Practically all controversial cluster portfolios significantly outperform the market and do so with statistical significance at the 5% level. And in most cases at the 1% level. Gray Ritchie summer in the 2016 issue of the Journal of Investing, Ritchie examined the risk adjusted returns of a portfolio constructed of firms from SIN or vice related industries using data from the Center for Research in Securities prices covering the period May 1995 to May 2015. He analyzed the performance of a vice portfolio made up of 41 corporations against the market portfolio. The firms in his vice portfolio came out, sorry, came from the alcohol, tobacco and gambling industries listed on the nice NASDAQ or NASDAQ OTC.
0:10:27.5 : He then added firms in the defense industry to complete the portfolio of vice stocks. Ritchie found that the vice fund produced a greater risk adjusted return compared to the results of the Carhartt four factor model over the market portfolio throughout the same period. The results were statistically significant at the 5% confidence level. What do you think?
0:10:50.3 : So I completely agree. Larry Swedro is really smart and he’s really good at factors and the whole like trying to discern where returns come from. I think also just you’d have to use the sniff test. I’m a big sniff test guy. If you have the ability to buy a sort of Vanguard total market index fund at three basis points fee, that’s a frictionless exposure to everything. And we know sometimes sectors have good runs, then they go down, they go up, they go down. Growth is in play, value is in play. We just saw it this year. Many ESG ETFs are underperforming because they tend to have a little bit of a tilt towards tech, which has high ESG scores and a little bit tilt towards growth. Those two are out of favor. The dirty oil stocks are having a great run and that’s been tough on them. So this year I think has reminded people that you’re right, it’s an active strategy. In a book I just wrote, I talk about how active is evolving. And one of the new ways is ESG. I find that’s like, active has a lot of faces and this is a new face of active.
0:11:53.1 : But they try to pull at your heart strings and your morals. And that’s what I find a little dangerous because it’s sort of pitched as you’re going to sleep at night and outperform and do good. And maybe you’ll sleep at night and maybe you’ll sleep at night, but the other two, we don’t know. You might outperform during a couple of years, then you’ll underperform. But over time it’s going to be higher fees. So I would argue if you took a Vanguard three basis point, classic index fund and you compared it versus an ESG fund that maybe costs, let’s say, we’ll be generous, 20 basis points only. Over 10, 20 years, I’d be very confident that the Vanguard one wins. The question some people are now asking is, well, is the underperformance worth it? And that’s where I don’t even think it’s worth it. So I’m not really sure. In my opinion, a lot of this is A, active and B, preying on slacktivism, which is the idea that I want to do good, but I don’t really want to make a lot of effort. I just want to feel like I’m doing something good and then I can go on my way and not, I don’t actually really care to look into whether it is actually doing good.
0:13:03.9 : I just want the feeling, thank you, and maybe a little superiority and I’m good. And I’ll pay an extra 10 basis points for that. So I worry there’s a lot of that. So I always tell the ESG people, I’m not totally anti ESG. I’m just anti nasty surprise. And I feel like over 10, 20 years, it’s possible somebody wakes up and goes, wow, I didn’t think I would underperform in this thing. Now I’m sad. I sold out my whole core index fund and replaced it with this ESG thing. I shouldn’t have done that.
0:13:32.8 : So some people say that ESG has saved active management because you can charge fees for it. I mean, you’d be very lucky to get away with just a 10 basis point increase to your fee levels from ESG. It’s often a lot more expensive than that. Honestly, the studies are all over the place about SynStock’s ESG outperformance. I think there are methodological issues with many of the studies and there are many different things going on. So one thing is if you look at fossil fuels, for example, they’re a very volatile sector. And so I’ve reviewed 118 years worth of data in all the studies that I looked at. And basically, it doesn’t matter whether you own fossil fuels or not, but it really matters when you divest or buy because the timing is hugely significant. I think actually somewhat the same thing is true. I think tobacco and alcohol, if you look at more recent years, the younger generation is not getting into those habits at the same level as others have. And so the most recent studies on tobacco, for example, don’t find the same outperformance. But again, all of that is beside the point. It doesn’t matter.
0:14:50.7 : It’s all, again, rearranging deck chairs on the Titanic because if you look at climate change, for example, the effect that climate change will have on your whole portfolio definitely dwarfs whatever fee levels or stock picking variation you’ll have from the index. So that’s why we have to actually try to address climate change. That would have a much better effect on your performance in the medium and long term than anything else. We can get into what I would suggest to help make that happen through investments, but basically it’s not through stock picking and you will just pay more as Eric was saying. All right. So the second point that we’ve kind of tossed around, and I want to just go back over this so that it’s really ingrained, all right. But it’s the idea of secondary market trading as having impact or being hurtful to the company. All right. And this is what I feel isn’t made clear when you see ESG marketed to investors and even to financial advisors. And I feel like a lot of financial advisors don’t even understand why not. Okay. So the idea that market participants can voluntarily change overarching global problems by the force of their market behavior is a flawed premise for the reasons that we’re going to describe.
0:16:12.5 : Okay. Secondary market trading doesn’t really impact the company. It’s an exchange of shares. The bad companies who are the offenders already have enough capital. All right. And they aren’t issuing shares. In the case of the S&P, a lot of times they aren’t issuing shares to fund their operations. In fact, they’re probably net buyers of shares. Okay. So according to Yardini Research, there was $200 billion of buybacks in quarter two, 2002 for S&P stocks. Okay. And Apple is sitting on over $200 billion in cash. Okay. There’s just a massive cash pile held by these companies. And if they need to boost their price back up, they can buy back stock. Basically, the stock market, you can think of it as like when someone lists, when a company lists on the stock market in the first place, it gets money. That helps because that’s a primary market transaction. But after that point, it’s just a bunch of swirling or it’s trading slash arguably gambling. And there’s no kind of… The publicly listed companies are actually usually returning money to shareholders. Yeah. Well, dividends or…
0:17:23.2 : Well, I would say that returning of the money is why you invest. I mean, that is… Well, yeah. That’s… I mean, forget ESG. That’s like why you want to be in stocks versus a commodity. There is that cash flow that you get a part of. So I agree. That’s a good thing for most people though. But in the case of ESG, that doesn’t matter.
0:17:46.6 : Yeah. But those same companies and many private companies and nationally owned oil companies and so on and so forth will be raising new money on the bond market. And that’s where 90% approximately of new capital flowing into fossil fuels comes from, for example. So if you’re going to have exclusions, the bond side is much more likely to have an effect. And indeed, there is evidence to suggest that that is the case. It has already affected cost of capital on the debt side. And if you have less demand on the debt side, you can raise less money and less of a good price. Whereas it’s just not like that with public equity because that’s not new money when you invest.
0:18:31.3 : Yeah. I like to sometimes imagine the stock market is a circle. It’s just a circle of people trading back and forth. And I think sometimes people need a visual, but that’s all it is. It’s just people going back and forth trading, which is why investment returns, the cash flow and the earnings growth is great. You get that over time. But the trading creates these little bubbles and it comes down. And I think that’s where sometimes in the past five years, the ESG strategy has done well simply because people value tech and growth wasn’t necessarily because of ESG. But again, that’s just speculative return that is very volatile and goes up and down. But it is gambling, although within the stock market, those people trading back and forth in a circle, there are plenty of people who are just in the market and not trading. Those would be investors. But the people who determine the prices are the people speculating.
0:19:32.0 : Totally agree. But if the shares get dumped, if all the ESG investors said, okay, let’s dump all shares of Exxon and the price plummeted, that would have the effect, though, of ticking off the executives who own that company’s stock on a personal level. So even there, it might not, because actually a majority of, especially in the US, the majority of the remuneration packages for executives are actually negotiated on the basis of the number of shares. So if the share price is actually artificially depressed, arguably, the executives are actually better off because they have under priced shares they can sell for. Anyway, so it’s actually, even there, I wouldn’t necessarily argue that you’re going to have a direct impact. And actually, yeah. Well, I would say, like, if there’s a lot of factor investors like Larry Swedroe and a bunch of them who really don’t care about any of this, and they’d love to buy up these cheap shares of an energy company based on their cash flow and their fundamentals being pretty sound.
0:20:43.4 : So you get to get a good amount of cash flow for a cheap price. Somebody is going to buy that. So it’ll probably just come right back up to where there’s an equilibrium. I agree. And even if like the, there’ve been some models that look at just really, really high levels of public equity divestment, and it takes an awful lot of that. I would say probably an unrealistic amount of that to really have an effect on a company anyway. But I agree, people come back in because it’s, and also Exxon’s huge. They’re so huge. There is one thing I heard. I was going to say, I was on a panel with the guy who runs the S&P 500 ESG index. And we were talking about this idea when, you know, they kicked Tesla off. It was a whole controversy. Even, you know, Elon weighed in, called ESG a scam. He was all, and then the companies that were in the index were like Pepsi and Exxon and everybody’s confused and it’s a whole mess. Anyway, on the panel, I was like, what good does this really even do? He did, here’s one case he did make there.
0:21:41.8 : He goes, we’re S&P. These companies want to be in our index and privately they will, they will, we do indirectly or indirectly put pressure on them to fix some of these metrics, simply because they don’t want the embarrassment of getting kicked out of such a, first of all, the ESG index. And that potentially, if they were to get sold off more, they get kicked out of the regular S&P. So there is some like, I want to be in the S&P membership club thing. I don’t know if you, I’m curious to get Ellen’s take on that.
0:22:15.8 : There are a couple of studies that support you actually. I think it does have more to do with kind of social discourse and the index effect. But yeah, that’s, there is some, some evidence to suggest that companies that are threatened with exclusion from an index are more likely to comply with the S&P. Exclusion from an index are more likely to comply with the standard of the index, comma, however, if you look at the data providers in the space, I mean, there’ve been lots of studies about how they disagree. They all measure different things. It’s a mess. But also like most of the stuff that they’re asking these companies to do well at have to do with disclosure only, or other kind of what I call means-based indicators. And if you look at the evidence around disclosure, it’s, there are more studies finding a negative correlation between improved environmental disclosure and actual environmental performance. Then there are studies suggesting that there’s a positive correlation, meaning much of the time it doesn’t actually help the company become any better when they disclose more. But often it’s the companies that want to distract from their really bad emissions by disclosing that are the ones doing the better disclosure.
0:23:25.6 : And again, none of this changes the actual emissions. The planet doesn’t care whether your disclosure is good.
0:23:31.1 : Right. And this is the greenwashing that happens, right? With that. And then there was an article on Bloomberg, which got into this a little bit, which I’m just curious to get your reaction is like, they were saying that even the companies that are the polluters that you want to see do better, a lot of them are just buying credits or somehow they’re not actually not, they’re not actually changing their behavior. They’re just financing their way around it. But the, that does have a downstream impact because it, those credits or that money goes to a solar company or somebody who is doing that kind of a thing. So there is a downstream positive impact, but the company got its ESG score up without really doing anything.
0:24:20.5 : So it’s actually even worse than what you say because offsets, for example, there’s a study that suggests that about 95% of offsets do not sequester the carbon promised. And in general, I’m very skeptical of that field. So having companies meet these commitments through offsetting or credits, I don’t think that’s credible. Also, I mean, as, you know, Oliver Hart and Luigi Vingales have written, there’s a comparative advantage for companies in preventing externalities from costing society in the first place. Like to try to clean this stuff up afterwards doesn’t make any sense if you can prevent it from happening in the first place. The prevention, you know, pound of cure, all that, all of the sayings on this ring true. It’s going to be just a point for the audience. What is an offset? So it’s basically like a religious indulgence, effectively. So if you emit a ton of carbon, you can pay somebody else to hypothetically sequester or reduce the equivalent in their own emissions. And the problem is, is that, I mean, a lot of these are, yeah, anyway, this could be a whole other episode, Sarah, actually. But basically, it’s a way of not having to actually decrease your own emissions, but instead getting someone else to do it, supposedly, which is kind of the problem.
0:25:44.7 : There are, you know, carbon credit schemes that are, like there’s one in the EU and so on and so forth. Like it depends on who does it and what it is. But in general, the whole idea of offsets in particular, quite problematic. And yeah, probably better to actually be emissions at source. But to me, this adds only another layer of confusion and ineffectiveness. Because even if you got the right ESG ETF that you just can live with and sleep at night and all that jazz, some of the companies that make it in probably do this number. So the greenwashing underneath the fund is a whole nother layer that most regular people cannot go that deep into due diligence and figure this out. I mean, I guess if you follow like certain like green publications, maybe they’re going to talk about this a little bit. But again, the vast majority of people that ESG is being pitched to are regular people and advisors who are just have that feeling like I want to be that person who has the green portfolio and I can, you know, not be investing in the bad people and the bad things.
0:26:57.6 : And it’s pitched so simply. But again, you unpack this and it’s layer upon layer of like inconsistencies, confusion, lack of transparency. Also, the ESG industry also does itself no favor because we talked about the E, the S and the G. And the things that make up the E and the S and the G, there’s maybe, I don’t know, 15 metrics under each give or take. They never get explained to normal people. The ESG people don’t really do a good job. And so a regular person has an image of a company like Tesla and thinks this has to be an ESG company. It’s out there making cars. But the scores are much more detailed and wide ranging than just what the company does. Right. So right. There’s so many levels. That’s what I wanted to get into next. That was my third reason. This is this is another thing is that ESG ratings are just a form of signaling. And a lot of times they’re quite insubstantial. So it’s unclear who the good and the bad stocks are because ESG scores are just signaling. There’s no universal meaning that has anything true behind it. OK, the ratings are assigned by different rating companies.
0:28:14.5 : It’s not regulated. And they’re all different from one to the next and how they evaluate these companies. It’s not like in the corporate bond market where we have Fitch and Moody’s and S&P. Right. There’s this huge disparity between how one rating agency is doing it and the next one. So, I mean, none of it matters is the problem. Right. Like, we’re spending a lot of time on these disagreeing ratings. Yes, they disagree. Yes, they measure irrelevant things, in my view, for the most part. Again, it tends to be like indicators of indicators, reporting and disclosure instead of actual impact. But none of that matters because the ratings are typically applied only to public equity holdings anyway. So it’s all like it’s rearranging of deck chairs on the deck of another deck of another deck. Like it’s just it’s uselessness piled on top of more uselessness. Oh, man, I honestly I thought I was the most like the biggest skeptic. I’ve met my hero. I think this takes the whole conversation and just makes it almost an exercise in futility. This public compass, you know, if you’re on the secondary market, you might as well just not bother.
0:29:30.8 : I mean, there are other things to do.
0:29:33.3 : There are other things you can do. I do have some hope. But yeah, you’re right. I am usually the most skeptical person in the room.
0:29:39.7 : I mean, it’s funny where you talked about impact and going to primary market. I’d love to get your take on this one thing that this against I’m more sniff test. I’m not an ESG person, but I have to cover it because I cover ETF. So I don’t know four to 3% of my world is ESG, right? But when I go to ESG, it’s be taken up a little more of my time because it’s such a debatable issue. And there’s so much hype and I have to push back against it. So I’ve heard about it a lot. But one thing I’ve come to some conclusion of is naturally is what you did, which is I don’t know how much you can actually do good with your portfolio. It seems like the way to do this is through the government like voting and regulation. And as a consumer, it seems like you have way more power as a voter and a consumer than you do as an investor. But the investing seems to be a place where it can be expedited. You could get more fees there. So they’ve really grabbed onto this lane as a way to change.
0:30:40.2 : But it just seems like the weakest lane of the other choices. What do you think of that?
0:30:45.8 : I think that it can ease ahead of consumer behavior pretty easily actually for reasons we can get into if that’s helpful, but not the way it’s currently being done at all. So there are other things that can be done as an investor because there are… So actually, I mean, I agree with you about voting and regulation, huge, comma, however. All of that whole process… So I’m Canadian, right? And we’ve got intense fossil fuel capture of policymaking in my country. And that is actually something that is within the control of large institutional investors because it’s these companies that are doing that lobbying directly or through trade associations. So that’s one aspect. That’s something that could very concretely be done to help improve the political process and the outcomes associated with it. So that’s huge. But also, I’m more of a subscriber to the view of universal owners. So basically everybody now these days, other than the speculators we were talking about before, own a more or less representative slice of the whole economy. And therefore, you have to think about externalities. You have to think about things that some companies are doing in your portfolio that are hurting everything else.
0:32:06.7 : And part of the problem is that many of the companies that have the greatest externalities, the greatest that impose the greatest costs on everything else in your portfolio, are domiciled in a country that may not want to regulate that because it’s pretty profitable. But if you own, if you’ve got investors from around the world who can force behavior change, that’s a way of kind of leveling the playing field across jurisdictions and therefore supporting the kind of regulation that we would want to see too. Because if you can get enough behavior change from the company in the reluctant country, then that company might actually want its smaller competitors to actually be regulated to meet the same standard that they’ve been forced to achieve through investor pressure. So that’s part of the theory. It’s all an assemblage though. You do need the, I mean, there’s probably nothing more important than government regulation and your influence over that by voting. And then the other thing about consumption, I’ve had ESG people before say that’s just not really that big of a deal.
0:33:09.7 : But I think to normal people who look at ESG and then they, or they see somebody talking about climate change, you may even believe in climate change, but you’re just unable to change anything about your lifestyle that’s inconvenient. And even like very wealthy climate change advocates just fly on private jets and there doesn’t seem to be any inconvenient choices being made. And it seems like inconvenient choices are absolutely necessary and would get more followers than just talking. But maybe I’m wrong. Maybe the talking and there’s just one or two switches that can be flipped all of a sudden. But I’ve always thought that if you want to make Exxon ESG just demand green energy, like the demand will, supply will react to demand. And sometimes I feel like ESG is trying to force supply to change demand, but demand is clearly, if you can’t change demand, what’s the point of messing with supply?
0:34:11.5 : So I think that’s a very logical train of thought, but there’s a reason that the fossil fuel companies actually funded the whole carbon footprinting exercise. And it’s because they know that actually without system change, individual behavior change is really, really hard. So there’s actually no credible way to demand green energy in your home, because usually that’s difficult to do, maybe even impossible, and especially to get kind of additional demand from consumers. And the fossil fuel companies understood that very well, right? Like if I want to take only public transport, I need there to be good public transport. Like it doesn’t actually, the connection between even quite a few people deciding to take more public transport, that’s not going to make the difference. What does make the difference there is governments actually supporting investment in public transport. I do think if you’re Al Gore and you’re flying around in your private jet, yeah, you should make a different choice and it is going to probably be more inconvenient because that’s an outsize effect on overall emissions. And again, the rich are actually very disproportionately contributing to emissions anyway. But for the average person, what’s going to be much more effective is to work on voting and then to pressure pension funds and banks with whom you have a direct relationship, because those are the big blocks of capital that can actually push companies.
0:35:35.5 : But how much does the whole economy have to change? Because aren’t the rich really the ones rich now, rich because of globalization and like everybody moving all over all the time and stuff being shipped and everything just flying all over the place. Whereas, like remember during the pandemic where people like just stayed home and walked down the street and everything just came to a standstill. And I had this feeling like this might be what has to happen. Like globalization will have to resort to localization because you can’t just send everything everywhere all the time, right? Or is the proposal to make everything you’re sending and moving and flying and this all somehow green and not having an impact on the atmosphere?
0:36:20.1 : I think that’s a really, really interesting question. I think one of the disturbing things about what we saw in the pandemic is that even with, I mean, it’s like the ultimate experiment in consumer choice, except for that people didn’t choose it, but no one knew basically for a while. And it only cut down emissions and demand for oil by a relatively modest amount, because it’s the system, right? Moving things around still accounts for a huge percentage of overall demand for oil. And gas is built into lots of our systems, heating homes and electricity. These things aren’t things that individuals can shift, even with the most extreme example of everybody staying home for quite a long time. So yeah, that just seems like… But the interesting thing actually is that as we move away from fossil fuels, we will de facto be localizing our economies more, because I mean, most oil and gas are exported and therefore imported, whereas with renewables, that’s really not the case. It’s something like 3% of renewables get exported across the border, whereas it’s like two thirds for oil and gas. So yeah, I think it’s an interesting thought exercise, but we will see de facto less movement of at least some goods, just as an automatic response to the penetration of renewables into the system.
0:37:53.3 : Then there’s also the idea of companies engaging in ESG just for the purposes of virtue signaling, so that they can get their ESG scores up. So in a sense, the companies that are the subject of ESG are trying to game the system, and they do. Completely agree. What’s the signal if most of the indicators are, are you reporting this, are you disclosing this? It actually gives a roadmap for anybody who wants to game the system to do so. They’re very happy to produce a report and not do anything else. If you go on Twitter and you just see the CEOs tweeting things like…
0:38:32.8 : The signaling thing you talked about, that’s where the CEO comes out for or against something. Again, that’s probably slacktivism. That’s just someone trying to say, I’m a good person. I’m into this issue. There’s actually ETF that came out here called Yall, the God Bless America ETF, which purposely, it invested in the market, but it takes those companies out if the CEO does anything that’s virtue signaling, which is… That’s how many ETFs there are. There’s an ETF that’s called God Bless America. That’s how many ETFs there are. There’s an ETF that does that.
0:39:03.3 : Yep. There’s starting to be some scrutiny of these types of claims though. That’s the good news. In the UK, HSBC has been pulled up because they’ve been advertising their green stuff, but of course, they’re one of the world’s largest financer of fossil fuels. Similarly, in Canada, RBC, also one of the world’s largest financer of fossil fuels has been pulled up for its green advertising. Because it is misleading, but finally, we’re starting to see that that signaling sometimes have some negative consequences if it doesn’t match reality, which it pretty much always doesn’t.
0:39:39.9 : The G. We’ve talked about the E a lot. The G is about this governance thing. I was exploring this for Warren Buffett, because they really value independent directors on a board, which makes sense. You want an independent… But he says, I have been on 20 public company corporate boards, and I’ve seen a lot of them operate, and the independent directors in many cases are the least independent. If the income you receive as a corporate director, which typically may be around 250,000 a year, that’s an important part of your income, and you hope to get on some other boards, and then the CEO calls and says, how so and so, and the current CEO, your CEO says, oh, he’s fine, he never raises any problems, then you’re likely to get on another board for another 250K. How in the world is that independent? Because Berkshire sucks in the G, and they are not in any ESG ETFs. People find that shocking too. They’re like, Warren Buffett, he’s a big philanthropist. He also sticks to the E, by the way. The E too. I get it. The E as well. But the G, he brings up again another point that makes you think.
0:40:50.7 : Look, this actually links to some of the positive stuff that comes out of the research in this area.
0:40:56.9 : So I’m not saying this is a silver bullet at all, but there is some evidence to suggest that voting against the re-election of directors, like retaining the shares of a company you disagree with, voting against the re-election of directors, it’s actually pretty embarrassing for somebody who’s got that dynamic going on behind the scenes. These are high status individuals, even if they get 90% of the vote, that’s a slap in the face often. So combining that with denying primary market capital to the same company, you can have that kind of personal embarrassment element plus potential effect on cost of capital, and together those could plausibly actually have an influence on a company. And again, the other thing that you kind of end up concluding in this space is that we need a diversity of different tactics, and it’s the kind of assemblage of them that’s most likely to produce a result. And that’s what you see if you look at examples like apartheid South Africa, and so on and so forth. It was like layering on of a bunch of tactics. And I think we have to use the strongest tactics that we’ve got, and those appear to be voting against the re-election of directors and denying primary market capital like bond money for a new bond issue.
0:42:06.6 : So you’re bringing up voting, and this is where there’s two dimensions to this argument. There’s an ESG fund that picks stocks based on these metrics, right? That’s a whole thing. That’s investing ESG. Then there’s, that’s the what? That’s the Titanic.
0:42:23.1 : Yeah, that’s the Titanic. That’s the Titanic.
0:42:25.7 : What about this, though? What about you’ve got Vanguard BlackRock, State Street, own about 20% of every American company, the way they vote their shares and how much impact does that actually have? Because there’s a company called Engine Number One, which says, here’s how we’re going to do it. We’re going to just serve you beta. So we’ll hold all the stocks, but we’re going to be activists and push for these things and try to get in the ear of these bigger investors. And they had some success with Exxon. And then that’s how they’re going to do it. And that’s more the proxy voting method. Would you find that to be less Titanic-ish? Yep. Yep. With a couple of caveats. So, I mean, one is like, I do, I would personally, if I had any money, I would probably personally invest in index funds, but I would be very careful about which company I went with. And I definitely wouldn’t go with any of the top three that you just mentioned because their voting records are poor and they are primary market purchasers of all sorts of things we wouldn’t want. But I think it’s much more credible to just track the market and then be much more aggressive.
0:43:31.8 : Shareholder resolutions, though, definitely don’t vote against them because I actually feel like that could hold back progress. But shareholder resolutions, I think, are more of like a longer-term social discourse thing, more so than directly immediately effective because most of them are disclosure-based only, as we’ve been discussing. Most still don’t pass. And then even if they pass, the implementation rate is actually quite poor. And again, if you’re just implementing write a report, that’s not very useful anyway. So I’m a little bit more skeptical of shareholder resolutions unless there’s a lot going on behind them, which I have seen good examples of that, but very few. Because it’s funny, just one thing on this. It’s crazy, BlackRock to me is probably the best example. Vanguard doesn’t say much, so nobody bothers them that much, even though they’re a bigger owner of most stocks. But BlackRock, like Larry Fink came out and said, oh, we’re serious about climate change. But then it kind of threw him into the middle of this. And what’s crazy, BlackRock will have protests outside of their office with climate activists on Monday. And then on Tuesday, it’s coal miners who are pissed off at them.
0:44:46.8 : Or it’s like Florida and Louisiana divesting their pension funds from anything BlackRock-related. And so they get hit from the left and the right. And they put themselves in that position by sort of going into this situation. But I do have some sympathy for how difficult it must be to be one of these companies. So what they started to do, and I think this is probably smart, maybe Ellen disagrees, at least from, if I was them, I’d probably do this. They’re going to turn over or give you an option as an investor in their index funds to either, I believe you could use a third party. And you can pick from, I guess, a couple third parties who might be consistent with your belief system. Because there’s no way they can vote on all these resolutions. They’re too complicated and time consuming. Nobody would do this. No, but no one votes proxies. Right. So Schwab is going to poll the investors and figure out where their head is on these issues and then vote accordingly. But at least giving the end investor a choice of like, OK, BlackRock, I trust you vote how you want or I’ll use this third party.
0:45:54.2 : I don’t know. They’re taking some initial early steps in that direction. I get why they do it. This would probably take a little heat off of them because they could say, well, I’m not doing the voting. It’s my 30 million investors. But then you’ve got all these different views who might actually just end up in the same spot BlackRock is, which is we’re going to be middle of the road and not try to piss off anybody.
0:46:16.4 : There’s a lot in there. So one thing is coal miners should not be mad at BlackRock because they’ve only excluded 18 coal companies out of hundreds and only from their active business when they’re much more a passive house. They’re not hurting coal miners. I find it quite funny that they’ve gotten this anti-ESG blowback for basically doing nothing. And basically the reason that they get picked on too is because they do have a kind of hypocritical approach to this. Sorry to put it that way. Talking a big game but not matching it with what they actually do. I am very skeptical of the voting choice move that they’ve made. I agree with you that it probably makes sense for them to do it, but I much prefer the polling of beneficiaries approach. The way that if you look at behavioral psychology, behavioral finance, people go with defaults to such a degree that you’re just not going to get a lot of opt-in preferences. And therefore what BlackRock does as a house will still account for the vast majority of votes, but there will be less pressure on them to actually vote appropriately with that market power.
0:47:37.9 : So I much prefer the option of polling beneficiaries and voting accordingly. Also, I think it’s more democratic generally.
0:47:46.2 : Yeah, I agree with you. I think polling is where I land. That’s the Schwab method. Vanguard and BlackRock, it’s not quite the same, but I think they’re experimenting. I think one of these will take root. Maybe the polling method will. But I think this is the direction it’s going. Right or wrong? I think the one thing that I think most people… I cover passive investing, and there’s all these passive attacks like it’s ruining fundamental, it’s doing this and that. And most of them are just like sour grapes from active managers. But the one that I thought had the biggest resonance is this, which most people can just understand is like the concentration of power with BlackRock and Vanguard in particular, they each own 15%. And at the rate the flows are going, they’re going to own 20, 30% of most of America’s companies in the next decade, because they take in about two thirds of all the new cash invested in America. And so they’re going to be hugely influenced unless they get regulated and the government just says, you cannot get any bigger, which is possible. But anyway, that point is, so there’s a corporate governance group that sits in New York that works for BlackRock.
0:48:58.1 : Let’s just say there’s 10 people. I don’t know exactly how many others. There’s 10 people. They don’t own that much of any company. It’s 30 million people who own 8% of Exxon. But those 10 people are able to make that vote. I get why that seems problematic. It just seems undemocratic to not to have those people which really don’t own those shares. It’s their investors not have them involved in the process at all. And I think that was one of the biggest legit worries about the rise of passive was the concentration of power in those two firms. But this is, I think one step to deal with that. I think there’s a bill in Congress about that. Senator Dan Sullivan of Alaska proposed that portfolio managers or portfolio management companies are not allowed, should not be allowed to vote proxies of index funds.
0:49:52.9 : Yeah, this is another thing that was brought up by the guy from Janice for the op-ed in the Wall Street Journal saying just they shouldn’t be allowed to vote. Part of me understands this. But I talked to my ESG friends and they think that passive at least take summit ESG into account. Whereas active just wants profits. They’re a little more cutthroat. Don’t care. And they may actually encourage pollution because they want more profits and they don’t want to those extra costs. I think the combo is healthy. Passive has a little more, much more long term viewpoint. They’re never going to sell the stock. They can. Active can sell tomorrow. So I think maybe both actually, you might get the best of both worlds. So I’m of that camp. But I can understand why they would put this bill in. But that you know, if you’re ESG, I think you would not like this bill. Am I wrong, Ellen? We’re just it’s only active managers.
0:50:49.6 : Well, I actually I think it’s really worth distinguishing between fund managers and asset owners. Right. Pension funds, endowments, etc. I this is controversial, but like I would much rather that pension funds vote than fund managers. Because fund managers are trying to get more business all the time. So they don’t want to piss off the sorry, I don’t know if you have language restrictions. OK, great. They don’t want to piss off the pension fund of a company they’re trying to get the business of. Right. So like Exxon’s got a pension fund associated with it. Right. All of its employees will pay into that that pension fund. BlackRock wants that business. So there you know, there’s a limit to how much they’re going to want to be bold, even when they’re really extreme externalities. That these companies are causing. Whereas a pension fund is going, how am I going to pay out my liabilities in 30 years with catastrophic climate change, depressing the value of my entire portfolio when I’ve got like fixed liabilities to pay back in some cases. For them, they’ve got much more of a long term view, first of all, but also the right incentives to actually protect the basis on which they are able to pay back the liabilities that they’re contractually obligated to pay out.
0:52:10.9 : So they’re the ones who are going to try to reduce those externalities in the first place and protect the whole portfolio because you can’t stock pick your way out of these risks anyway. There’s no point in doing that. You have to actually try to change company behavior to internalize externalities. All right. Last points about why ESG is so important. Why ESG sucks on my list here, ESG comes with higher fees. Exchange traded funds that explicitly focus on socially responsible investments have, according to one study, 43% higher fees than widely popular standard ETFs.
0:52:47.4 : Unquote. Yeah, this is this is where the new active, you know, or active management trying to just because the book I recently wrote is called the Bogle Effect about just the epic bomb that Bogle and Vanguard dropped on asset management. It’s changed everything. More and more people going passive that’s pushed active to get creative. The T. Rowe Price Blend Fund thing is just sort of dying. So what do you do? Right. So one of the new ways is ESG. We’re going to pick stocks based on these other metrics. They charge a little more. I will say some of them are pretty cheap. Like, in fact, ESG ETFs didn’t start getting assets until Vanguard came into the space and came out with a sub 20 basis point fund. 20 basis points is like the international demarcation low cost line. Anytime you go below 20, you tend to get bites from advisors. They love below 20. Anything in the teams or single digits, they’ll generally buy just because it’s cheap. Once that happens, BlackRock came in with ESG and Deutsche Bank and they all there’s now, I don’t know, a dozen of them under 20 basis points. And the biggest one is ESG.
0:53:50.3 : You most of the assets in that one come from BlackRock’s own model. So I can’t say there’s a lot of organic interest. BlackRock put it in its own models, which are subscribed to by advisors. It’s probably got 100 billion dollars of subscribership in that model that has 20 billion. It’s 15 basis points. But here’s the thing that is the problem. The the the more the cheap ones, they’re 1512 basis points. They generally hold the S&P 500 minus a couple tweaks. And the reason for that is if you are an advisor and you practically and you’re going to put a big chunk of this in your core, it cannot have much tracking error. You cannot have to explain to the client why it underperformed the S&P. So what the advisors actually like is the ESG label, but with the S&P and they’ll actually pay up a little for that. The ones that do maybe more true ESG on the Titanic, those are going to have more tracking error. They tend to cost a little more, but they’re endorsed more by the purists and the people who really are into this stuff who would think ESG is just a complete waste.
0:54:55.9 : Why? It does nothing except make you feel like you’ve done something. But that’s the biggest ESG fund in America is ESG. But to its credit, it is 15 basis points. That said, you can get beta for three. So it’s five times more than what you can get in beta. But this is where the construction of a portfolio comes into play and why I tend to be somewhat more bullish on thematic ESG like solar, because then you don’t have to dislodge your wonderful cheap beta exposure. You keep giving the money to Vanguard or BlackRock or in Ellen’s case, somebody she likes. And then you can add on a solar ETF into what I call the hot sauce lane. So most portfolios are 85% cheap beta 6040. And then people in that 15%, they want to go a little crazy. They want to do things that are speculative, fun, narrative based to cure their FOMO. And that’s where I find a home for things like solar, wind, clean energy ETFs, which are much more volatile, and they’ll charge a little more, but those are more thematic ESG. So there’s a couple layers to what you just said, but the cheaper the ESG ETFs are, the more likely they’re just full of beta and they don’t really do much.
0:56:12.8 : Although to be fair, none of those strategies that you’ve described do much. We’re all talking about life on Titanic. Yeah. Yeah. Yeah.
0:56:23.5 : So this is all with that in mind that we’re just having a conversation on the Titanic about 10 minutes after it hits the iceberg.
0:56:32.8 : Yeah. Yeah. So I mean, let’s just walk through this from the perspective like of an average person who’s got a pension, right? So let’s say that they decide, yeah, I care about climate change or some of these other issues. I’m going to invest in an ESG fund. Like, first of all, it’s almost certainly going to be one of the ones that you just talked about, where it’s like basically just the index with a couple of tweaks anyway, but they’re going to pay more for it. And then as Tarek Fancy says, it’s a dangerous placebo because then you’re going to kind of go, all right, done. Like my money is invested for good and I can go home and sleep well at night. Meanwhile, your pension, which is for most people, your pension and your house are really, that’s most of your assets, right? And it would be better for you as a pension beneficiary to have a pension fund that underperformed a healthy market than for it to outperform an unhealthy one. And guess what? Climate change is going to have a really serious effect on overall returns over the next 30 years. Hold on a second.
0:57:42.8 : Hold on.
0:57:43.3 : Yeah. Go ahead. I think you’re going to say the same thing as I am.
0:57:46.7 : Because you’ve said this twice and I want to make sure I’m not thinking of reasons for what you said being true. Can you explain that? Why is an unhealthy market bad for the stock market? So really good question. I’m glad we’re really properly digging into this. So climate change, of course, has like a bunch of direct effects that we can probably think about. So like most of the world’s real estate is uncomfortably close to the oceans and so on and so forth. Not most, but most large urban areas are near to a body of water. At least some of that and especially some really expensive stuff is very vulnerable to sea level rise. You can think about the fires, the floods, the extreme weather events, all of that stuff. So that’s stuff I think we all imagine and that’s totally legit. But then you think about second order effects, right? So like Florida’s insurance market is collapsing because of all of that. But also you end up with multiple breadbasket failures and so on and so forth because of drought that drives up food prices. And like that contributes directly to conflict and forced migration, which then is going to cause all sorts of issues like geopolitically.
0:59:11.9 : So if you really map out all of the effects of climate change on a portfolio, like you really do conclude it’s better to prevent this. There’s pretty much nothing that ends up being unaffected. And there are even unexpected connections. Like for example, sometimes hydro plants are having trouble operating right now because of droughts associated with climate change. So you end up with like these massive power bases that can’t work anymore. Volcanoes are more frequent and more severe because of climate change. I mean, all these things, it’s a system, right? And climate change gets everything out of whack. So if you’re in a world in which you have a really good pension fund manager that manages to outperform, which that’s hard anyway to outperform the market, but let’s say they do. And you’re dealing with hundreds of millions of forced migrants due to climate change. Like how are you going to get your money back for your retirement in that kind of situation where it’s this catastrophic outcome? It’s just not going to happen. I know what you mean by that. You’re saying, yeah, I totally get that. That’s a bigger, that’s thinking big, right? Thinking beyond your portfolio.
1:00:33.4 : I get it. My question was more on the pensions. Like in the US, it’s not a lot of that. Maybe in Canada, maybe there’s more, but a lot of people would invest through their defined contribution plan, which makes you pick one of these funds, or you work with an advisor who has access to most of the public funds, mutual funds and ETFs. If you add up those numbers, they get way, they eclipse the defined benefit market in the US by a lot. Yeah.
1:01:05.6 : I mean, defined benefit is declining everywhere pretty much anyway. But I think the main point that applies to all of these types of funds is that most of your returns come from beta. Most of your, I can’t say this enough actually. Most of your returns come from overall market returns. Whether you under or over perform, it tends to be pretty marginal. So if the overall economy is messed up because we allow runaway climate change to take hold, that’s a way bigger factor than the ability of your fund managers to outperform or not.
1:01:39.6 : Well, no, but my question was in your example, you said, if you have a pensioner and you want your pension fund manager to XYZ, in the case of somebody who has defined contribution, why don’t you walk through that? Like, okay, so for the regular person sitting with the DC plan and now start from there.
1:01:58.7 : Right. So, I mean, basically it doesn’t matter how you invest. If you are a regular person and let’s say you buy an ETF or you go to your advisor and you open up a 401k in the US, either way, you are mainly exposed to market risk and market performance. That’s the key thing. It doesn’t really matter how you do it. You’re not going to do like 400 times better than the market. Right. So if we have extreme effects on the overall financial system, which is slated to happen unless we address this issue, it doesn’t matter how you invest. It’s whether or not you’ve protected the whole system in the way that you’re investing. And again, that is also going to come down to a lot of government regulatory action as well. It’s not really not going to come from just pension, pension funds. So at your job, are there people real into publicly traded ESG strategies? Like, do you, or does everybody, I’m just curious, I know where I work, there’s a lot of people into this stuff. Like, so I tend to be like a little bit of the bad guy. Is everybody on the same page as you in the university level, or are they more like coming from where I’m coming from, where they just can’t quite accept the Titanic theory, because it’s just too much of an existential, it’s existentially too difficult to accept that.
1:03:29.7 : So I work with the senior administration of the university, but also the bursars of each of the colleges, because they all have their own endowments, there are 31 colleges, so that’s a lot of endowments. The bursars used to work in the city in a lot of cases, and in general, they are hard-nosed, practical people. So actually, like when we talk about, they’ve actually influenced my thinking a lot over the last few years. And I think we have quite a lot of convergence and a lot of skepticism about this space. And that’s why we actually spend our time mainly on things like directly bothering banks and fund managers to change their behavior, using the evidence base to actually get them to do things that matter, as opposed to the things that are rearranging the deck chairs on the Titanic. And there’s a lot of buy-in for that. I’m actually really deeply impressed and grateful because it does feel like there’s this real sense of common purpose there.
1:04:32.3 : Wow. By the way, can I say one thing, Ellen? First of all, do you have a podcast yourself or no? No. No. Okay. A, I think you should start one on these topics. And B, I have the perfect name for you, Comma However.
1:04:53.1 : That’s it. I just-No, but the name of the podcast would be ESG, Comma However. However. Yeah, maybe. Comma However.
1:05:04.1 : I have to say, I’ll give them an idea. Comma However, a real talk ESG podcast. There you go.
1:05:13.4 : Okay. So let’s just kind of summarize it here for the financial advisors who are listening to this. I mean, for me, I mean, I was ready to kick ESG out the door in the first place, which is why I called you both here. But I mean, let’s say that you somehow do want to use your money to make an impact or that you’re investing, you can’t help but invest, but you’re not the government, right? You can only, you vote and you vote your proxies or whatever. I mean, should somebody just take the money that they would have spent on those expensive ESG funds and then go and donate it to a charity that saves the whales or like, what’s the bottom line here, folks? I have a definite answer, but it’s because I’m totally doing exactly this. And it’s always evolving. So I feel like I’m learning new things about what to do. So this could be very well wrong, or I’ll consider it to be wrong in a couple of years. But I think it’s most important to, A, switch banks. So again, if you look at where most fossil fuel financing comes from, it’s really a debt story.
1:06:21.1 : And a fairly small number of global banks are the ones kind of piling that primary market capital into fossil fuel expansion, including through like utilities that are building new power plants and stuff like that. So I would definitely start there. But the other thing is to put pressure on your pension fund and or your fund manager to get them to vote against the reelection of directors and not participate in primary market issues of capital to companies that are misaligned. And I think focusing on those high impact strategies kind of cuts through. And a lot of these actors don’t hear from very many people. Like a pension fund is going to hear from a handful of people per year. So you’d be surprised how effective it can be to few more write in and have really directive evidence based proposals to take forward. People who work in pension funds have usually taken a pay cut to work there. And they work there usually because they have other reasons for wanting to be there. So they’re not going to they’re going to be more receptive, would be my guess, to those sorts of respects, those sorts of concerns, because they probably share them.
1:07:38.7 : But those are great, novel pieces of advice, no doubt. The pension funds, though, sometimes I’ll hear this, where they’ll be like, oh, yeah, ESG ETFs aren’t taken off that much. It’s really more of an institutional story. But again, we’re still on the Titanic here. And pension funds want to have their portfolio look a certain way and they will exclude stock. So why are they doing that if they’re that clued into what you’re talking about? Is that just for show? I’m not necessarily saying that they’re clued in. And I don’t think that’s for nefarious reasons. I think it’s counterintuitive. If you think, you know, I’m investing in a company, you think you’re helping it, right? And if I’m not investing in a company, I’m somehow hurting it, or at least not helping it. And that’s something that I still run into a lot with ESG professionals, right? So it’s, I actually think it’s a matter of getting the word out about what works and what doesn’t. But I do agree with you, I think there is pressure to do some of the stock picky stuff anyway, because the average person isn’t going to know this, even if their pension fund really does get it.
1:08:51.0 : So I’m sympathetic. The university has done a bunch of things that have more to do with social discourse stuff, because it recognizes that, actually, part of the reason is that there’s a recognition that if you stigmatize certain things, they’re more likely to be legislated. That’s how we tend to legislate things in society. So if you have more fame than money, I would personally tell you to do different things. But most pension funds, no one’s ever heard of, so it’s probably best for them to do the most strategic, high impact things that also, by the way, probably have fewer return implications, because you’re not stock picking, paying higher fees, etc. Yeah, no, that’s that I would say of all the people I’ve met, and I’m in the industry, I think that’s where I get a lot of people who want this to succeed. That they like we’re all on the type panic, I guess, in a way, because I’m in the funds industry, it’s all after secondary market. There’s private equity, of course, that I, you know, we have a guy on the team who writes about that a little bit, but that markets pretty small relative to the public markets.
1:09:59.8 : And most of the debate is about the public markets and the secondary markets and Exxon. And it’s interesting, I’ve definitely, I mean, I was skeptical to begin with. Somehow, I’m like, even more skeptical. But your point is, is well is well made. And I think it’s I’m curious why I haven’t read or heard that more, though. I the only time I hear what you’re saying is from somebody who might not even believe in climate change is coming from the right. They’ll be like, Oh, it’s all it’s all bullshit. Bs. You’re saying it almost like as the same as the BlackRock person. You’re, you’re so into this goal. This is a distraction. It’s interesting how those two people can have the same view. Yet they one is like, doesn’t even think climate change the risk. The other one is hardcore into it, but they have the same actual view of the SDSS. I find that kind of interesting. Just saying.
1:10:57.3 : Well, what might be useful for you, Eric, is that, like the very same types of analyses and exclusions or tilts or whatever else would be much more useful on the bond side, because actually ETFs participate in primary markets as well, or they contribute to demand in primary markets. So actually just applying some of the very same tools and filters and so on so forth to the bond side itself would be, you know, genuinely useful. So shifting the conversation to the very same to the very same companies, but with a bond ETF instead. That’s in fact, my team is scoping a bond index for that reason, because there just isn’t enough out there. There’s so many, so many. There’s a couple of green bond ETFs, but honestly, you know, my mind has been changed there. I will, I will, if we’re going to, you know, take a positive approach, we’ll stick to the bond side. 90, you said 90% of capital comes from debt, the debt side.
1:12:02.7 : 90% of new capital.
1:12:04.9 : Yeah, that’s it. Okay. That’s a great stat. But most of the debate, action, energy is on the equity side and the products. There’s very few bond ETFs that are ESG, but there’s, I don’t know, maybe 10. But there’s 200 ESG ETFs that are equity.
1:12:23.6 : Exactly. And by the way, I’m also skeptical of green bonds, but we don’t have to get into that now. But I think just like applying some of the same exclusions that you might apply on the public to the bond side. I also would like to particularly emphasize companies that are building new fossil fuel infrastructure that lock in demand and dependence on Russia also. So power plants, pipelines and so on. That’s the stuff that is going to be the source of more lock in. So that’s a good focus. Real quick.
1:12:53.8 : So you want it’s green. It’s the ESG screens, not green bonds. Yes. Yeah. Okay. Yeah. Now, here’s a question for you. Just real quick. I know, I know we’ve been on this a long time, but what’s your take on nuclear power? And thus use uranium minor ETF. I actually thought this might be green investing for realists because doesn’t nuclear really have to be a huge part of how we’re going to get to net zero?
1:13:27.6 : Sarah, do you want me to open up this can of worms? Are you welcoming this? Okay. So there are so many different considerations here. One thing to say, like you’re going to get me in trouble with my family, by the way, in answering this question. I would say keep the German nuclear power plants open. Like any existing nuclear power plants. Like if the alternative is to shut them off and run coal plants, like don’t do that. Seriously, keep them running, comma, however. Nuclear is really expensive and it isn’t actually, it’s not as flexible as other things. What we really need now in the grid is flexibility to be able to balance out renewables. And again, the cost, like it is really expensive and we actually don’t have enough uranium for this to really solve a significant percentage of the problem anyway. And it takes a really long time to build. And electricity has to be decarbonized before anything else. Like we need to do that right now. And the pricing is already there for us. Like renewables can compete with coal in all major markets and is nearing that level with gas pretty much everywhere as well.
1:14:37.8 : So yeah, I don’t think building new nuclear power plants is going to help us very much. It’ll cost more and it’s not going to be as adjusted. Like you have to, it’s a blunt tool, a nuclear power plant, right? You can’t just turn it on and off and so on. That’s a big issue given the shift in electricity systems that we’re seeing.
1:15:00.1 : Yeah, but the idea is it’s 24-7-365. This is, again, this is Bill Gates quote. I think Elon’s comment on it, they both seem pretty, Bill Gates in particular, but Bill Gates, I shouldn’t listen to Bill Gates. Yeah, I agree. I disagree with Bill Gates on quite a few things. But like there isn’t enough uranium anyway to make much of a dent in the problem. And again, like we have to decarbonize electricity now. It’s going to take 10 years to get those plants online and we can build a lot of renewables in that time and then do things like, I mean, I think we should probably do fairly simple but expensive stuff like pumped storage, which doesn’t rely on batteries. But like we’re going to end up with really cheap renewables and some like much more expensive but adjustable stuff because we actually don’t need power 24 hours a day, seven days a week. That’s the thing. We have peak times. We have to manage that. If we have grid upgrades, which are, by the way, insanely important, we can end up in a situation in which people’s electric vehicles end up kind of balancing out renewables because cars sit most of the time actually.
1:16:14.6 : So there can be a store of energy for when it’s needed. Anyway, I just think, I don’t think nuclear is the solution that people think it is because of the timing, the cost, the lack of flexibility and again, just like the nature of demand for electricity in the first place. But keep the ones that are already open. We’ve been talking for over an hour here.
1:16:44.0 : Okay. Well, I mean, I learned a lot. The thing with this is there’s so much to unpack. That’s why we cover it. It only makes up 2% of the assets, but it’s probably 10% of our coverage. But obviously, it’s not something I’m an expert in per se, but I’ve had to get really read up on it. But my sniff test, a lot of my alarm bells went off, just early sniff tests. Wait a second, especially the way the media was really pushing it. And this fits a lot of what the media likes to write about. And so my big thing was just sort of, but I definitely, a couple of things changed my mind today. So appreciate that. 1:17:29.0 : Well, that speaks to your cognitive flexibility. So that’s amazing. All right, good. So listen, everybody, did we convince you that ESG sucks? Drop me a line on social media and let me know. You know, I love these kinds of debates on there. And by the way, tune in for the next one by subscribing to my show, and please rate and review as well. Thanks, everybody. See you next time.
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Grillo Investment Management, LLC does not guarantee any specific level of performance, the success of any strategy that Grillo Investment Management, LLC may use, or the success of any program. Nothing in these materials may be construed as an investment, insurance, or financial recommendation.
Grillo Investment Management, LLC will strive to maintain current information however it may become out of date. Grillo Investment Management, LLC is under no obligation to advise users of subsequent changes to statements or information contained herein. This information is general in nature; for specific advice applicable to your current situation please contact a consultant or advisor.
Podcast transcription may differ from original recording and Grillo Investment Management, LLC may not be held liable for such differences.
Sara Grillo holds shares of Tesla, TSLA, in her personal account at the time of this blog being published.