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A few weeks ago we took a look at a new structure forming on Wall Street to capture the fast-growing ESG investing craze, and how this structure looks eerily similar to that of a crime family. For those who haven’t read the piece, it looks something like this:
Associates: public companies looking to improve their brand with pro-ESG policies, acting as the organization’s first line of defense & influence.
Soldiers: rating agencies, mainly MSCI, Moody’s & S&P Global, who police the associates through the use of ESG ratings that determine inclusion in ETFs & positive brand perception.
Capos: Stock exchanges that ensure ESG compliance with new listing standards and profit from ESG growth via the sale of new trading & market data products.
Underboss: Index providers like MSCI, S&P Global & FTSE Russell who decide which companies are included in their ESG benchmarks & collect rapidly growing fees as assets pour into ETFs linked to their indices.
Boss: The Big Three asset managers, led by BlackRock. BlackRock wields incredible voting power over every public company in America via its $9 trillion under management & deep political connections, which it uses to push a global pro-ESG agenda.
Quite a bit has happened in the ESG industry since I penned that initial piece. BlackRock launched a new ESG fund in early April - the U.S. Carbon Transition Readiness ETF - that raised over $1 billion on its first trading day, a new record. Vanguard began a serious hiring push into ESG with nearly a dozen new hires. Joe Biden’s administration signed new ESG legislation as a part of its broader COVID-19 stimulus package and is pushing the SEC on deeper ESG disclosures across public companies.
In spite of all this, perhaps the most important development came from someone who left the industry & shared their thoughts on the state of ESG investing in a recent USA Today op-ed. Tariq Fancy, a former BlackRock executive and investment banker, spoke out against the ESG apparatus forming in the US and globally. Here’s an excerpt from the article (emphasis added by me):
“As the former chief investment officer of Sustainable Investing at BlackRock, the largest asset manager in the world with $8.7 trillion in assets, I led the charge to incorporate environmental, social and governance (ESG) into our global investments. In fact, our messaging helped mainstream the concept that pursuing social good was also good for the bottom line. Sadly, that's all it is, a hopeful idea. In truth, sustainable investing boils down to little more than marketing hype, PR spin and disingenuous promises from the investment community.”
Woah. Let’s flesh this out for a minute. Tariq Fancy was not only a high ranking executive at BlackRock, he was CIO of Sustainable Investing. He led the group that dictated BlackRock’s entire ESG strategy. Other than perhaps CEO Larry Fink, Fancy was as close to being a Don in the ESG Mafia as anyone. When he speaks up about ESG investing practices, we should listen.
Fancy’s words are pretty damning considering his background & experience. Later in the article he goes so far as to compare climate change to cancer & ESG investing to wheatgrass - “a well-marketed, profitable idea that has no chance of curing or even slowing down the cancer.” Someone with unique & broad visibility into the ESG Mafia’s inner workings is outright declaring that the movement doesn’t make any meaningful progress towards improving environmental, social or governance issues.
Should we believe him? I certainly do. We don’t just have to take Fancy at his word to see how hollow the ESG message turns out to be. I believe the ESG Mafia’s core message suffers from three fatal flaws:
Confusing and in many cases conflicting metrics & messages.
A startling lack of accountability.
Few if any tools to measure true ESG impact.
Investors interested in ESG investing need to understand what they’re buying & come to terms with the fact that Wall Street may not be the environmental savior their marketing material makes them out to be.
Aggregate Confusion
In late 2019 researchers at MIT finished a years-long study of ESG ratings among the industry’s top providers: MSCI, Moody’s, S&P Global, Morninstar, and Refinitiv. Among many important findings, the study showed that agencies give materially different ESG ratings for the same company. The biggest reason for this discrepancy is scope - each agency looks at different metrics & measures these metrics differently to determine if a company ranks high or low on their ESG scale. One agency might focus heavily on lobbying activities when others do not, or measure “lobbying activities” in an esoteric way. Even small differences across all 709 ESG inputs in the study begin to impact rating divergence materially, to the point where a company could get an above-average rating from one agency and a poor rating from another.
If I’m the CEO of a public company and I care about my ESG score, which agency’s rating should I trust? If I wanted to raise my score, which metrics should I pay attention to? Much of the ESG rating process is proprietary and kept confidential by the agency, giving me very little information to try and improve. If I’m an investor looking to buy “ESG stocks”, which ones do I buy? The ones highly rated by MSCI or S&P?
Compare this to popular & widely accepted credit ratings issued by the same firms. Variance in credit ratings is much smaller across the industry and is correlated with clear, measurable metrics - likelihood of default. Sure, there’s some grey area there, but if I’m a CEO and my company has a poor credit rating, I know the path to improving it pretty clearly. Not so with ESG. The impact of confusing & conflicting metrics alone is enough for me to question ESG’s framework, as these ratings affect every other part of the process, from benchmark inclusion & AUM flows to future legislation.
Wholesale Lack Of Accountability
Similar to the above issue & along the lines of unclear definitions of ESG, fund managers are disingenuously re-branding themselves as “ESG-focused” without changing anything about their investment process. With so much money flowing into the movement as of late, we can hardly blame these funds for chasing investor interest in the name of growth.
What we can blame is a system that allows them to do this unchecked. There aren’t clear rules in place today that say “funds can only call themselves ESG when XYZ things have happened”, and accountability measures are few & far between. The SEC did recently form an ESG Task Force to help combat abuse of the ESG label, but its impact on industry compliance remains to be seen. The task force is just as focused on policing company ESG disclosures as it is on investigating funds.
For now, there remain plenty of ESG funds with core holdings of pollution-heavy oil & gas stocks, gun manufacturers, and even crypto miners, all seemingly the antithesis of ESG investing. Are these funds abusing the label? In order for the SEC to decide, they’ll have to come up with an internal rating system of their own. I think regulators will run into challenges when trying to police the ESG Mafia because it will involve making black & white claims about a practice that is anything but.
No Actual Impact on E, S, or G
If a confusing ratings system or lack of accountability hasn’t swayed you, consider the fact that there is no way to connect ESG inflows to real world progress.
Let’s say you decide to put $1,000 in an ESG ETF. In return, the ETF’s manager buys a $1,000 basket of stocks that track an ESG benchmark, including companies with good ESG ratings. In effect, all your $1,000 did was reward companies included in this benchmark with a higher stock pice, based on past ESG performance. Current benchmark construction forces managers to focus on company metrics at a point in time - what is my ESG performance today - rather than trends.
A separate MIT study from late 2020 argues that ESG investing should be about change - how will companies improve ESG metrics in the future and what portfolio decisions can we make today to accelerate this change? ESG investing in its current form merely rewards companies for things they’ve already achieved, and does nothing to incentivize future progress.
Final Thoughts
Ultimately, I believe ESG investing comes down to a simple choice. How do investors want their money to work for them? Do they want their investments to set them up for retirement through a reasonable rate of return & years of compounding, or do they want it to help improve the environment?
The ESG Mafia wants you to believe the answer is “both”. They want to you believe that buying their products with a simple push of a button can let you retire wealthy with little work or investing knowledge, while at the same time reversing climate change, improving board diversity and reining in excessive C-suite compensation, all for a few basis points in fees per year. I don’t think such a silver bullet will ever exist. A former Don in the ESG Mafia recently and very publicly declared as much.
I really do want to see E, S and G improvement across public and private companies, and I understand that takes investment in the form of both labor & capital. I’m merely pointing out that Wall Street has a fiduciary mandate from their shareholders to maximize profit, and ESG investing by definition can’t compromise this mandate. Investors have a responsibility not to entrust the future of our planet to an industry designed & built for the sole purpose of making money.
Honorable Mentions
On April 12 the NYSE announced the launch of First Trade NFTs, securitized tokens commemorating the instant a company goes public on its exchange. The first round of NFTs will include Spotify, Snowflake, DoorDash, Coupang, Roblox, and Unity and will be available for viewing/auction on crypto.com.
Speaking of crypto - in case you hadn’t heard, this little under-the-radar exchange called Coinbase went public on April 14, trading at valuations as high as $110 billion on its opening day before paring gains to end the week. Coinbase’s IPO is being called a “watershed moment” for the crypto industry as Bitcoin hits new all time highs at ~$64,000 per coin.
In a move celebrated by insomniacs & trading addicts around the world, CBOE announced its plan to extend trading hours for its flagship VIX & SPX options complex to nearly 24 hours.
Chart of the Week
BlackRock reported earnings on April 15 where it cemented its status at the top of the asset management industry & Wall Street once again. BlackRock’s revenue grew +19% YoY driven by strong net inflows across all product categories & a rising equity market boosting AUM values. Operating margins expanded to nearly 45% and EPS jumped +18% vs. Q1 2020. For a company as large as BlackRock to grow in the strong double digits, even in a bull market, is truly astonishing. The “active to passive” trend has been building for over a decade, but results like these show there may still be some years left for the trend to play out.
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Disclaimer: I am not a financial advisor. Nothing on this site or in the Front Month newsletter should be considered investment advice. Any discussion about future results or projections may not pan out as expected. Do your own research & speak to a licensed professional before making any investment decisions. As of the publishing of this newsletter, I am long ICE, CME, TW, NDAQ and VIRT. I am also long Ethereum.