HyperNormalTimes

Written by our Director of Equity Advisory, Jeremy McKeown, the HyperNormalTimes provides in-depth and considered long-term commentary on major macroeconomic and market-shaping themes.

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June 5, 2022

ESG – Time for change in values-based investing

One value dear to my heart is the value of being able to swim and enjoy the water. I want to give more people the opportunity to learn to swim and get the many benefits it brings. On July 16th I will be swimming the 6km from Averton Gifford to Bantham in Devon. I’m raising money for Level Water, a charity that uses the power of swimming to improve the lives of children with disabilities. Starting with 1-1 swimming lessons, they provide opportunities for the children to learn to swim. From physical development to social and emotional confidence, swimming is a vehicle to change lives for the better. It did for me, and I know it has for many others fortunate enough to have access to a pool. The swim is on a beautiful stretch of river estuary in fresh clear tidal water. I am more than happy to pay the required sponsorship of £200 to have the privilege of doing this lovely swim. However, I thought I would take the opportunity to ask any of you who got some value or enjoyment from my blogs or podcasts over the past year to make a small contribution to this worthy cause. Please no more than a couple of quid. Here is my Just Giving link. Thanks in advance, Jeremy. 

Anthropogenic climate change is a problem that humanity needs to solve. Racial and gender equality are vital pillars of a free society. I am not a fan of badger culling, and I am worried about the plight of the British hedgehog. We all have values. They result from the aspirations and goal-oriented behaviours we adopt as individuals. Over time, these values and priorities change as our knowledge about our world changes. I am currently concerned about the river’s water quality, where I enjoy swimming. But it is a personal priority. I don’t expect there to be an international outcry. If I were living in Ukraine, I would order my values differently. As we assimilate the changes in our world, our collective value priorities change.

ESG is good because it imposes values on the investment process. How can we possibly object to this? Capitalism is nasty, selfish, dirty and aggressive. Not to mention toxically masculine. How could independent entities such as companies act for the common good? They use fossil fuels and harmful technologies and exploit everything in their path. Someone must impose constraints on these actors. This view is seductive as it is simplistic and unwittingly dangerous.

I have never subscribed to the view that others can dictate what my values should be. I regard that as an abdication of being human. In this regard, I have been nervous about the onward march of ESG and its band of responsible investors. By definition, responsible investors imply the rest of us are irresponsible, and I, for one, object to this.

The police raid on the offices of the Deutsche Bank offshoot, DWS, is the latest in a spate of recent controversies in ESG investing. HSBC has suspended its Asset Management Head of Responsible Investing, Stuart Kirk, for suggesting that we might be collectively overestimating the financial impact of climate change. S&P decided to eject EV pioneer Tesla from its ESG Index, prompting Elon Musk to tweet that he thought ESG was a scam.

Less well publicised was the case of Anne Simpson, Head of Responsible Investments at Franklin Templeton. Anne, until recently ESG supremo at Calpers, told a conference that “energy security and poverty reduction have suddenly become as important as the green transition”. As far as her ESG scorecard was concerned, this comment reveals that these things were not equal until February this year. OK, perhaps before the invasion of Ukraine, I can understand how energy security had slipped down the rankings, but poverty reduction? I, for one, would have voted against that motion. But I was never asked.

The ESG movement of responsible investing has taken the investment world by storm over the past 20 years. There is little doubt that it has changed the way we allocate capital. Like any market, the world’s capital markets are imperfect. They are the worst means of allocating capital, apart from all the others. They have evolved over centuries of trial and error. But as weighing machines over the long term, our financial markets assimilate our knowledge as best they can and give us a number.

However, while modern capital markets constantly change the cost of capital for different entities, ESG is less adaptable. As Gillian Tett pointed out in the FT, the behaviour of the Russian government was never considered an ESG issue before February 2022, never mind its long-running human rights abuses. Now we see it for what it is. But, the perception of Russian aggression in our order of priorities also depends on where you are. We think differently about this in the UK than we might if we lived in Eastern Europe.

Meanwhile, this week President Biden has to bite his lip and go cap in hand to a Saudi Arabian man widely believed responsible for the murder of a journalist on foreign soil and ask him to supply us with more oil. Is this acceptable behaviour from an ESG perspective? Through the lens of the Russian atrocities in Ukraine, maybe MBS is a good ally. It is undoubtedly illustrative of how our priorities can change.

As serial energy entrepreneur Andrew Austin, now Executive Chairman and founder of Kistos PLC, eloquently described in the latest episode of In the Company of Mavericks, managing our energy transition must change due to the events of the last 12 months. Andrew makes a strong case for developing low carbon natural gas, proximate to its end market as an essential bridging fuel to our fully renewable future. His point of view is as self-interested as my desire to swim in a clean river, but it also deserves wider attention.

The ESG movement has successfully grafted its taxonomy to our investment processes and capital markets. Investors and companies are scrambling to keep up with what is essentially adding the qualitative values data to the traditional quantitative financial data. This exercise of adding apples and pears creates confusion and the opportunity for manipulation and fraud. In November last year, the accounting body IFRS said it intends to release a global baseline of sustainability-related disclosure standards that provide investors and other capital market participants with information about companies’ sustainability-related risks and opportunities. I applaud their ambition but remain sceptical. Meanwhile, Google trends suggest that searches for the term greenwashing have gone up threefold over the last year.

ESG risks becoming a weapon in the financial repression our monetary authorities need to impose on financial markets. Fifty police cars arriving unannounced at the front door of DWS in Frankfurt last week highlight the increasing political significance of ESG and the seriousness of the greenwashing crime. It would appear that regulators will play a crucial role in determining the definitions, terminology and language of ESG. Time to dust down Orwell’s 1984 and reacquaint ourselves with The Ministry of Truth.

Governments are heavily conflicted regarding capital allocation issues, particularly in a world of persistently negative real interest rates. As Neil Record recently highlighted, the idea that the Bank of England is independent of the UK Treasury is similar to the notion that Roman Abramovich is independent of Vladimir Putin. Suffice to say, ESG regulation offers a potentially irresistible means of financial control where inflation is allowed to run hotter than interest rates. This policy suits most governments just fine but will make investors and savers worse off.

ESG is not a bad idea, but it needs adaptation. Gillian Tett said that we are in “a new era of digital transparency, but [have seen] a collapse of popular faith in the power of governments to fix problems.” We are not about to return to the simplistic shareholder maximisation mantra of Milton Friedman. The behavioural values we prioritise in the companies we want to invest in are available to us like never before. In the days of Friedman, there were no data points on employment policy from Glassdoor reviews or customer satisfaction scores from Trust Pilot. Today we have the data. Companies are releasing a lot of this themselves, and we can corroborate what they tell us.

However, as far as the impact of ESG is concerned there are significant unintended consequences. ESG, like BAME in the realm of racial equality, is a restrictive catch-all term that is losing its purpose. We need a more human-centric self serve approach to values-based investing. Delivering better data to end-user investors is a good place to start.

Jeremy

Ealing

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