Reassessing The BRT
As inflows continue to rise, institutional asset managers validate its pragmatism, and government policy realigns with more sustainable approaches, the anti-ESG crowd is making its final stand to stop ESG from becoming mainstream. Years ago, majority sentiment said sustainable investing, or SRI (socially responsible investing), served only as a niche approach for the “tree-huggers” and ultra-progressives. Now, the consideration of all stakeholders (not just shareholders) in investment decisions has become more commonly understood and accepted—and not just for the sake of investor values, but for the legitimate materiality to long-term returns.
Two years ago, the Business Roundtable (BRT) made news when it shifted away from the concept of shareholder primacy. The August 2019 Statement on the Purpose of a Corporation, signed by major CEOs like JPMorgan's Jamie Dimon, Apple's Tim Cook, and Walmart's Doug McMillon said, “Each of our stakeholders is essential. We commit to deliver value to all of them, for the future success of our companies, our communities and our country.” But two years after that breakthrough statement, researchers at Harvard Law School say it was “mostly for show.” Their research included an analysis of corporate bylaws, proxy statements, governance guidelines, and other corporate documents, finding little differences from two years prior.
And yet, over the last two years amid the pandemic, climate disasters, and the murder of George Floyd, many companies made very clear changes to benefit the planet, customers, workers, and communities. Companies like Home Depot and Target, for example, increased wages and overtime pay while extending sick leave. JPMorgan publicly announced it would seek to lend trillions to renewable energy and dramatically reduce its lending to the fossil fuels industry.
While just 45% of the 100 largest U.S. companies disclosed racial/ethnic board diversity in 2019, a total of 83% reported the same in 2021—a 38-percentage-point increase, as companies continued to recognize both the moral necessity and the business benefits of better diversity and inclusion efforts.
Sustainability efforts and a more long-term mindset aren’t brought to life by corporate bylaws but in the core values and social contract that companies have with stakeholders. To this point, our partners at JUST Capital reviewed the performance of BRT companies in its JUST 100 list. About 37% of signatories were in the JUST 100, and the majority landed in the top half of the rankings. These companies tended to outperform non-signatory companies and did well on community and worker issues. Equity returns for the BRT signatory companies also outperformed the Russell 2000 Index. So, while there is still work to be done to better measure stakeholder value creation and provide consistent disclosure, the evidence suggests sustainability is good for people, planet, and shareholder returns.
What Seeds is doing. The concept of stakeholder primacy is imbedded in Seeds’ overall investment philosophy and process. We are also partnered with JUST Capital to measure the impact of Seeds portfolios versus market indices. Our process added several companies to certain portfolios in the past quarter that perform well from a social impact perspective, including Comcast Corp., Thermo Fischer Scientific, and Bank of New York Mellon.
Market Volatility Reemerged
Financial markets faced a reemergence of volatility after a mostly steady first half of the year. While the S&P 500 rose 0.3% during the entire quarter, markets fell 5% from their peak on Sept. 2 through the end of the quarter as investors assessed inflation risks amid supply chain pressures, rising interest rates, slowing corporate earnings, and the looming threat of the Delta variant.
On average, Seeds large cap equity portfolios fell by 6% since the end of August through the end of the quarter. Health care and technology in particular contributed to the decline. The consumer and financial sectors fell but held up better than the overall market. At Seeds, we remain satisfied with year-to-date average performance of 22% through the end of the quarter. While we expect greater market volatility over the short term, we view individual stock laggards as opportunities for tax-loss harvesting and adding high-quality, sustainable companies at more reasonable valuations.
Investors Get More ESG Access
In early October, the Labor Department proposed a rule change that reverses Trump Administration policies related to sustainable investing in retirement accounts. The new rule, called Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights, permits a consideration of environmental and social factors (or “ESG” issues) when considering retirement investment options, meaning investors can incorporate issues like climate change because such factors can materially affect the long-term viability of companies. Last May, President Biden asked the Labor Department to consider suspending or rescinding the Trump-era rule on ESG investments. The new rule, expected to go into effect after a 60-day comment period, comes after the Labor Department consulted with various consumer groups and asset managers.
What Seeds is doing. A consideration of environmental and social factors has always been integral to Seeds’ investment process. We are pleased to see that policy will now empower investors’ growing desire to better understand material ESG risk and to better align investment portfolios with values.
Poor Sustainability Practices May Lead To Facebook Shakeup
While Facebook (FB) has faced past criticism, thousands of internal documents recently uncovered and delivered to the Securities and Exchange Commission by a whistleblower has put the company’s malfeasance back in the spotlight. On Oct.3, 60 Minutes aired an interview with Frances Haugen, a former Facebook product manager, who discussed how the company’s algorithms serve to amplify hate speech and misinformation. By failing to protect its users from misinformation and deepening political divisions around the world, Facebook is hurting its users and even our democratic process. Clearly, such practices represent material ESG risks for the company over the long term, and investors, both for the sake of returns and personal values, will likely take notice. Increasing public backlash over Facebook and its Instagram platform are likely to lead to more lawsuits and increased scrutiny from regulators and Capitol Hill.
Facebook has become a massive company, with 2.8 billion daily users, over $100 billion of revenues, and a trillion-dollar market capitalization. In our view, Facebook’s sustainability problems may lead to greater efforts (and costs) to police its community and stamp out inappropriate content, which could lower revenue and raise costs. Operating margins have already fallen from almost 50% in 2017 to 43% in the first half of 2021. We see further margin erosion ahead as the company may increase spending on content moderation, a group which includes over 15,000 people and is assisted by AI-driven tools. Lawsuits and regulatory burdens could also harm the company’s financial position.
There are several pending class-action lawsuits dealing with violations of securities laws, antitrust concerns, and inadequate consumer protections. Given these growing concerns, FB stock has underperformed the S&P 500 by about 11% over the past 52 weeks ended Oct. 20.
What Seeds is doing. Seeds does not own FB stock in any of its portfolios. Our view since inception is that Facebook is a negative force in society and that its business model is not sustainable in current form. We also question the strength of Facebook’s corporate governance since the company has not done enough to protect users and provide a safer community. The fact that Mark Zuckerberg has a majority 58%voting control is also a concern from a governance perspective. Our process might allow Seeds portfolios to own FB in the future, but only after the company has gone through a massive transformation.
For more information on the Seeds Portfolios over the last quarter, read What's Blooming: October 2021 - As The Anti-ESG Crowd Makes Its Final Stand, Stakeholder Primacy Is Alive & Well