In a new series of Streetwise columns for The Wall Street Journal, senior markets columnist James Mackintosh shares his thoughts on “the failed promise of funds guided by environmental, social and governance principles, known as ESG.” In the first of the series, titled, “Why the Sustainable Investment Craze Is Flawed,” Mackintosh explains how opportunistic big banks and asset managers have taken advantage of people who want to “feel good about themselves,” despite his belief that new ESG investment products “don’t do much to make the world a better place.”
Mackintosh’s anti-ESG stance and others like it lean on a simple premise: Investors have been hoodwinked. It can’t be true, according to the premise, that millions of reasonably informed investors finally realized they could align financial goals with fundamental values—that they had some real autonomy over their own money and could choose not to empower immoral corporate behavior by way of their hard-earned retirement portfolios. Surely, despite trillions of dollars in ESG inflows, it’s all still merely a “craze.” And all these naïve investors need saving.
That isn’t to say incumbents haven’t clearly taken advantage of the opportunity as ESG exploded in popularity (because, capitalism, right?). There’s no doubt that greenwashing and other issues in the industry have become widespread, creating a complicated puzzle for regulators to solve. But, as with many anti-sustainable investment arguments, Mackintosh seems to purposely diminish the positives and exaggerate the negatives—all while avoiding the nuance in between—to make his points. It’s not that criticism of the space in general is unfair or unimportant. It is. But, as with many things these days, we’d all be better off exploring nuance together, somewhere in the rational middle, for the sake of real progress (and profits, too!).
To that end, we’ve decided to review the column nearly line-by-line. We have not included every line of his article, so we encourage you to read it in full first. His words are bolded and quoted below.
“ESG funds, as they are known, promise to invest in companies with better environmental, social and governance attributes, to save the planet, improve worker conditions or, in the case of the U.S. Vegan Climate ETF, prevent animals from being eaten.
Money has poured into ESG funds as noisy lobby groups push pension funds, university endowments and some central banks to shift their investments. The United Nations-supported Principles for Responsible Investment says signatories have $121 trillion of assets under management; even assuming lots of double-counting, that is most of the world’s managed money.
Over the next few weeks, Streetwise will explore the explosion of ESG investing and why I think it is mostly—but not completely—a waste of time. I will also offer up some solutions and discuss how to use your money to make a difference, while understanding the inevitable trade-offs.”
Just about any anti-ESG argument these days seems to start with this type of conflation—a total bundling and reduction of a complex set of ideas, investment frameworks, and intended outcomes into a singular and simple process with a singular and simple intended outcome.
Then comes the cherry-picking. The U.S. Vegan ETF has become a go-to example of egregious mislabeling, even among veteran ESG professionals and proponents. While the label suggests that the fund might include companies specifically seeking to protect animals as part of their very business model (like Beyond Meat), the fund merely screens a broad index to include companies that don’t test their products on animals (like Google), among other basic factors.
This is one of the crucial problems with almost any anti-ESG argument: It’s not about fair, rational critique (for which, again, even most ESG proponents would agree) but about wholesale rejection of a complex set of ideas, investment frameworks, and intended outcomes. It can only be baby out with the bathwater. And for good measure, the argument says trade-offs are inherent; profits and moral progress can simply never coexist.
“ESG supporters can point to what look like successes: Their pressure has encouraged many companies to sell off dirty power plants, mines and, in the case of Anglo-Australian miner BHP, its oil business. It has even forced board changes at Exxon Mobil.”
Next comes the diminishment of any material progress clearly resulting from the tectonic shift toward more values-aligned investment decisions. This short list, which captures just a fraction of very clear changes to corporate behavior on a massive scale, does in fact represent actual, very significant successes. But according to Mackintosh, they only “look like successes,” since, as he explains:
“… selling off assets or shares by itself does nothing to save the planet, because someone else bought them.”
Mackintosh must know that this isn’t how it works. Yes, selling shares means someone is on the other side of that trade. But the resulting selling pressure from that trade leads to lower prices. It is simply inaccurate to claim that the proliferation of ESG investment options (and investor demand for those options), alongside shareholder engagement, has not materially affected share prices of very large corporations. They have, and corporations have in turn changed policies and behaviors as a result.
“Just as much oil and coal is dug up and burned as before, under different ownership.”
“Rich people who want to make the world greener could make a difference, by buying and closing dirty businesses even when they are profitable. So far, though, this hasn’t happened in any significant way.”
Because it’s ridiculous. It’s another all-or-nothing argument, whereby we can’t progress without first achieving moral perfection. We can accomplish nothing of substance without first fixing the human condition, rewiring ourselves to act solely based on unbridled altruism.
This “perfection as the enemy of progress” paradox has played out similarly for decades in the world of charitable giving, where donors won’t give to clearly impactful organizations until their CEOs work without a salary. (Dan Pallotta explains this brilliantly in a TED Talk.) We’re simply not allowed to do good while also doing good for ourselves. And so we sit on our hands until we somehow unwind our own evolution.
“Someone has to take a loss somewhere if fossil fuels are going to be left in the ground rather than extracted and sold. ESG investors’ hope is that the losses will fall on other people. The problem is that less environmentally-minded investors buying those shares, oil wells or power plants are absolutely not going to shut them down unless they stop being profitable.”
Long-term investors reluctant to invest in a dying industry aren’t hoping “the losses will fall on other people.” They’re hoping to avoid losses themselves. This argument instead paints a picture of a simple, binary system, where values-based investors play hot potato with purely pragmatic investors—forever on the opposite side of the trade. But that’s not what’s actually happening. Because pragmatism and values motives are not mutually exclusive ideas. The argument also seems to suggest that profitability determines investor decisions, but that investor decisions don’t affect profitability. The performance of public companies is inherently intertwined with public markets in complex ways. The argument also seems to suggest that present-day profitability is the sole—or at least primary—determinant of shareholder value. It’s very often not. (See: Tesla.)
“It might make sense for an investor or company to sell out of fossil fuels early if they think the retreat from coal and oil is inevitable—indeed, that was the pitch by the activist who took on Exxon—but that is simply to invest according to a political prediction, not a way to fight climate change.”
This, again, is one of the fundamental problems often embedded in anti-ESG arguments, that only deeply ideological, political motives drive ESG professionals and investors. And yet, believing that we will likely transition away from digging up nonrenewable resources to power our planet—and that this paradigm shift is already being priced into traditional oil and gas versus more renewable energy—is inherently apolitical. It’s logical.
“There are three big pro-ESG arguments, which sound reasonable, but have major flaws.
First, if companies treat the environment, workers, suppliers and customers better, it will be better for business. This could work where companies have missed something to boost profits, such as add solar panels on a sunny roof or create a better employee retention program. Early ESG activists plucked the low-hanging fruit here, but management has become painfully aware of changing customer and employee expectations, so there is less opportunity ahead.”
So, in one article, Mackintosh is essentially saying that ESG investors have at once influenced no corporate progress at all, and, somehow, have so drastically influenced progress that corporations simply have nothing ESG-related left to do that might improve their bottom line or shareholder value. But it’s hard to believe that massive, multinational companies who have, as Mackintosh says, installed “solar panels on a sunny roof” have “less opportunity ahead” to improve when it comes to their ESG risk exposure.
“Adding costs to reduce a company’s carbon footprint, or paying staff more, should only help the stock price if it also raises revenue or reduces other costs, by say generating more loyalty from carbon-conscious consumers, lowering staff turnover or improving relations with regulators.”
“The second ESG point is that by shunning stocks or bonds of dirty companies, and embracing those of clean companies, it will direct capital away from bad things and toward good ones. After all, a lower stock price or higher borrowing cost in the bond market should make it less attractive for dirty companies to expand, and vice versa for clean companies.
In practice, there has been a very weak link between the cost of capital and overall corporate investment for at least a couple of decades. Small changes in the cost of capital pale in comparison to the risk and return projections of a new project.
That is not to say there is no link. Tesla, with extremely expensive shares, has repeatedly taken advantage of its ability to issue new stock to invest in factories and research. The high prices early last year for clean-energy stocks might have encouraged similar corporate investment. The flip side of course is that buying wildly overpriced shares isn’t a good way to make money, as losses of a third or more from this year’s peaks for clean-energy stocks shows. Shifting the cost of capital just might help save the planet, but after the short-term shift in valuations is over, it should lead to underperformance.”
This is another common anti-ESG argument that assumes that, primarily, ESG investor preferences have created out-of-control stock valuations. Sure, momentum shifts into renewables have played out amid Biden’s presidential agenda, for example. But Mackintosh’s so-called red-blooded capitalists are as much to blame for chasing trends and driving up valuations in companies like Tesla. Meanwhile, ESG integration is not mutually exclusive from fundamental analysis. Investors can seek companies that both reduce their ESG risk exposures and trade at reasonable valuations.
“The third claim from some ESG investors is that they are just trying to make money, and that involves shunning firms that are taking unpriced risks with the environment, workers or customers. Since they call themselves “sustainable” or use “ESG integration,” funds doing this look very like the rest of the ESG industry. The selection principle of the most popular ESG indexes, for instance, those from MSCI, involves identifying only risks that are financially material.
I would say, sure. If you think the government is going to, say, raise fuel taxes, don’t buy manufacturers of gas-guzzlers. If you think the government will impose more restrictions on coal plants, then coal generation will be an even less attractive investment.”
Mackintosh is right that assessing ESG metrics is about assessing and reducing material risk exposure. But his examples reflect a one-dimensional view of risk. In reality, it’s not just that the government may raise fuel taxes. It’s that, in addition, the product’s production is in constant battle with Mother Nature, requires massive physical infrastructure exposed to the elements (like deep-sea wells in the Gulf of Mexico, for example), and an incredibly complex process and supply chain to deliver.
"My big concern about ESG investing is that it distracts everyone from the work that really needs to be done. Rather than vainly try to direct the flow of money to the right causes, it is simpler and far more effective to tax or regulate the things we as a society agree are bad and subsidize the things we think are good. The wonder of capitalism is that the money will then flow by itself."
This is always the anti-ESG punchline: No matter the improvements we can and must make in the ESG investment industry, ESG investing will never make a meaningful difference, so government regulation is therefore necessary. It's frivolous to believe we, as individuals, have any autonomy to effect change at scale. Instead, we should accept that our hard-earned dollars must empower failing industries that harm the world and people, in hopes that one day, the government, known for its moral motives and effectiveness, will, on its own volition, step in to save the world on our behalf.
And yet, ironically, the ESG investing movement that Mackintosh believes is filled only with feel-good emptiness is the very force behind the increasing government scrutiny on corporate behavior he believes is so needed. Individuals therefore have, in fact, created change at scale. And they certainly have commanded attention, even enough to warrant a Wall Street Journal column series.