Interest in ESG investing surged following the pandemic.
While the term ESG (environmental, social, and governance) has been around since the early 2000s, something about the “Great Resignation” and the social justice movements of pandemic life brought it to the forefront of investment discussions.
Despite recent criticisms on ESG grading and corporate “greenwashing,” interest in ESG continues to climb. Even with its opponents, the question remains: isn’t the practice of ethical investing based on environmental, social, and corporate governance behaviors… well… good?
To find out, we asked two investment professionals with differing opinions — Andrew Rodriguez (CEO, Change Finance) and Chris Ryon, CFA (Portfolio Manager, City Different Investments) — to weigh in on the pros and cons of ESG investing.
Andrew, how did you get into ESG investing?
Change Finance got into ESG because of the public demand. We saw a need for a type of investment instrument that really wasn’t available, which at the time was a “fossil fuel-free” portfolio. Even with macro studies saying there was alpha generated by ESG, that wasn’t what was driving folks. People care about sustainability and climate change, and they don’t want any “trade-offs” with their values. So we set out to build that.
But today, there’s a growing awareness among American and international investors, as well. They want alignment between how they invest and how they want the world to look. It’s the disconnect that keeps them up at night. For those folks, strategies like ESG make a lot of sense. Will they outperform in every market? Not necessarily. But that may not be their top priority.
I hear what you are saying Andrew, but the thing that irks me a bit is when I hear the motto for ESG: “do better by doing good.” That’s fine. There are going to be times when ESG-driven funds do extremely well compared to everything else — but there are going to be times when they don't. I think right now is an example of when they're out of favor because the things ESG will not invest in are doing extremely well. Energy. Defense. Things like that.
Think of a college endowment. I work with a university’s student-managed funds program. There's always feedback coming from the Board about divesting non-ESG assets — to “do good.”
If you believe your ESG portfolio is going to underperform a well-diversified portfolio without ESG constraints, what could you do with the extra proceeds of the well-diversified portfolio? Are you hurting your overall goal of “doing good” if you’re putting fewer proceeds in your pocket? If you can provide ten scholarships with a well-diversified portfolio, but only seven scholarships with an ESG-only portfolio, that’s where “doing good” could get sticky.
But can an ethical investor have a positive impact by owning part of these companies and pushing for change? Say, a big oil company like Exxon?
How would one make money in a company like Exxon in three years, five years, or ten years down the road? As they figure that out, there's absolutely a case for owning them, getting involved, and making a difference.
Now, the fossil fuel constraint that we're under at Change Finance is self-imposed. It's our sense of the long-term investment landscape for fossil fuels as much as any other reason. My struggle is whether or not a fossil fuel company is a fundamentally bad investment if its revenue engine is gone within 10, 20, or 50 years.
This notion makes a lot of sense: that by owning an investment in the fossil fuels industry, you may change what they're doing. On the flip side, how do you say that you are opposed to what is happening in an industry, if not with your pocketbook?
I think by staying away from those industries, by not letting them acquire capital, you're hurting the long-term prospects for the issues most important to the investor. That's not saying do it blindly. I mean, you have to say, hey, what's your plan? What have you accomplished? How effective have you been? And that's what an annual report does. And that's what a shareholder meeting does, especially if you get somebody with this mindset on the Board. And that's working within the system versus outside the system.
The environmental impact of companies has been an indicator of “doing good” for years, but how do you see a company’s social and corporate transparency trending?
I absolutely want ESG to pay more attention to social behaviors. I think this is probably the place where they pay the least attention to the largest risk. And the expert in this thinking is Kate Raworth who wrote “Doughnut Economics.” She says that yes, there is an existential environmental crisis, but if we don't build the human foundations so that everyone can be well to thrive in that sustainable world, then people don't feel the freedom to get up and work there.
I think we're missing the big cycles that are affecting labor markets. For the longest time, probably the last 40 years, management has had all the leverage over labor. But here we are, 3.6% unemployment and 10 million-plus unfilled jobs. I think the leverage is switching to labor.
You know, if I was going to invest purely on social behaviors, I would look to a manager like you, Chris. And I’m not just being nice here. You’ve had a track record of hiring diversely and giving people opportunities, which in this space is a big part of building the kind of prosperity that allows people to think and be a part of more.
Well, thank you, Andrew. I do believe that, in most things in life, character counts — especially in investing. And in the people you work with.
What other alternatives are out there for investors?
I think separately managed accounts (SMAs) are a great vehicle to achieve ESG investing. Defining ESG for the mass market is difficult because it's such a personal choice.
Let me share one example. When I worked at a large mutual fund firm, I would get letters from California residents saying, “Why are you investing in California jail bonds? We think they are completely inappropriate and immoral.”
My response would be, “I appreciate your concern, but they are valid tax-exempt instruments in the state of California, and therefore are available to be invested in, and we will continue to do so.”
That same shareholder could have gone into an SMA and said, “I don't want jail bonds” and we wouldn't have invested in them.
Chris, I really like your perspective on SMAs. We see a lot of clients who, even in ESG investing, have one industry or sector they prefer to avoid for any number of reasons. We’ve touched on some of those sectors. Energy. Healthcare.
And that's why I like SMAs as the vehicle for ESG investing because it's still personal. Individuals can set any constraints, based on any factor — and they can live with the consequences.
Thank you to Andrew Rodriguez and Chris Ryon for the fascinating, spirited discussion on ESG investing. If you’re interested in learning more about separately managed accounts (SMAs) or ESG, schedule a call with City Different Investments. And look for more discussions like this from us in the future.
The views and opinions expressed by individuals are their own and not the views or opinions of their employer.
Information contained herein is for informational purposes only and should not be construed as investment advice or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. It does not constitute a general or personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual investors.
Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product or any non-investment related content, made reference to directly or indirectly herein will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.
Visitors to the City Different Investments web and social media sites are asked to read these terms