ESG Investing: Fact or Fiction

Esg stands for environmental , social and governance . Esg isn't just one thing , like climate change . It's a whole bunch of things , many unrelated . All mixed together , it's a bit like a meatloaf or a fruitcake . Esg is simply an amorphous concept . An industry of ESG rating agencies has emerged to try to profit from attempts to resolve this confusion .

However , these agencies have only worsened the confusion . There are dozens of indicators that go into the ESG ratings . Different rating agencies use different indicators and can apply different weights . As a result , the ratings can vary significantly among agencies . As such , the value of these ratings is questionable .

Beyond the confusion over how to measure something so amorphous , there's an awful lot to dispute over what ESG is actually supposed to do . That's where the FT's opinion piece comes in . The underlying thrust of the editorial is that ESG is essentially a branding exercise by folks trying to promote investment products .

We all know that branding involves storytelling and indeed several stories have been told about ESG . According to the author , the ESG promoters have had to change their sales story repeatedly as regulatory and investor doubts grew .

Initially , the ESG promoters were branding ESG as a way of avoiding investing in bad things from a societal perspective and favoring investing in good things . You've probably heard the expression doing good while doing well . That sums up the initial ESG sales story .

Now it's quite legitimate for an investor to seek to exclude specific kinds of stocks they find morally objectionable from their own personal portfolios or to focus on stocks that promote certain moral causes . This is often called socially responsible investing . Steve , I know you have had clients who have asked for customized SRI portfolios .

There was the Sisters of Sinclair , who were in order of nuns who live in a monastery , and they focused on buying things they could believe in , and so they were one of the first socially responsible investors at SSGA and their lives are dedicated to prayer and good works , and for these sisters , they wanted their money to be similarly dedicated to things that were

one not gonna hurt the environment that God gave us and two , also follow the rules that are out there . So one of the names that had a problem was GE , because at the time they had a plant that had gotten some fines for releasing chemicals into the Hudson River , and so at the time , in around 2000 , it was unheard of for somebody to not own GE .

They didn't own a lot of energy names or industrials or utilities , and I look back at that and the sisters did very well . The portfolio was overweight towards technology , 2000 , 2001, .

It got hurt in 2001 and two , but the main purpose was they felt very comfortable owning what they owned and they were very aware that they were overweight , one area which they felt was more of the future and very underweight areas that they felt might have been a carbon-based past .

And when I think about that 23 years ago , I kind of believe that the reincarnation , with ESG , of socially responsible was bound to come back as people start to question their faith and some of the things going on in the business community .

A second example is a client here in Atlanta has a family foundation that's dedicated to faith-based causes and he wanted to have us build a portfolio that would be free of the names he felt were conflicting with those faith-based values .

So I think the terms and the breadth of socially responsible and ESG are all things that are in flux and I think that the biggest problem I've had with this idea is the concept that your returns are as good or your risk is lower , when in reality I think it's just a different set of risks and a different set of returns , not necessarily one that is better or

worse than you would get on your own . What do you think about the different animal that is ESG ?

Of course , all of these individuals hold different personal , individualized views of what's objectionable or preferable , and yet the ESG providers are offering them the exact same portfolio , so it's not customized to personal preferences or objections .

So with thousands or millions investing in the same standard portfolio , the doing good while doing well sales story doesn't really pass fiduciary muster . Per the FT opinion piece , once the ESG promoters were called out on this fiduciary problem , they changed their sales story .

They now characterized ESG as a way of reducing risk in a portfolio Without , at the same time , reducing returns . This was a clever way of trying to pass fiduciary muster . However , there were several problems with this new story , as Steve alluded to . First , there's no reliable way of measuring ESG . Since the ESG ratings are a mess .

It's not even really possible to calculate ESG driven risk and return in terms of normal financial risk and return . Second , there is not much evidence that a climate sensitive portfolio , which many of these ESG portfolios attempt to be , can sustainably improve risk returns .

For example , there are times when high oil prices boost energy stocks which , as you can imagine , are typically underweight in an ESG portfolio . Since high oil prices are always possible , does it really make sense to completely rule out energy stocks ? What do you think , steve ?

I think that there's times when we need to work with companies who might be doing things better in terms of new research into different forms of less carbon based energy products .

Esg portfolios tend to overweight asset , like technology stocks , and underweight others , like industrials , energy or utilities . Obviously , significantly overweighting any one sector can be risky to your portfolio .

There are times when the technology sector can be hit very badly and ignoring the value in energy stocks , with a PE is of eight to 10 times earnings , feels like you could be missing an opportunity . I think it really comes down to how strictly do you want to define these things and how .

I agree with you that it trying to define one term for everyone is not necessarily giving you the best solution .

Basically , the ESG promoters saw that ESG portfolios struggled when energy and industrial stocks did better than tech stocks , and they needed a new story . Disclosures are something that nobody can complain about . The more disclosure the better , is my view , and the more precise the better .

Having a precise number for carbon intensity is much more useful than having some random ESG rating . Some companies also publish their own ESG reports . These do contain a lot of self promotion , but they likely also contain some very useful and important data points as well . Probably more standardization in this area is needed .

However , everybody should complain about comprehensive disclosures . If a company faces problems relating to the health of its workers or consumer complaints about products , or is pumping out a lot of carbon , it's more likely to get sued . Wouldn't you want to know if a company faces severe legal or reputation risks ?

Thus , it's really better to have more disclosures than not to have them . On that basis , investors can make better decisions about stocks . But again , please don't be fooled if you're told that standard ESG portfolios reduce risks , improve returns or allow you to do good while doing well by your own definition of what doing good means . Steve .

So I've decided to make an allocation in my portfolio to our faith-based strategy , because I believe you got to eat your own cooking .

I think that , when I look at it , the values that we're espousing are recommended to us from the US College of Catholic Bishops and we're trying to come up with what I consider to be a strong portfolio forwarding names equally divided in the sectors like the S&P . So I feel that some part of my assets should be invested in that way .

Is it all of my assets invested this way ? No , but it is some of the assets in my retirement account and I kind of believe that managers who don't invest in their own strategies they raise a pretty big issue and a flag for me .

So , yes , my answer would be I follow the ESG principles of the US College of Catholic Bishops in terms of investing , and it's not all my assets , but it's a significant portion . How about you , Clem ?

In my personal investment portfolio , I do not explicitly pick stocks or design my portfolio even some of it around some notion of ESG . Instead , I use a set of structured criteria , mostly quantitative , for picking the stocks in my personal portfolio .

Even these criteria , however , my portfolio usually has no oil or gas and no utilities and no bank stocks , so I am light on those areas and so my portfolio may indeed look pretty good on ESG , but I'm not starting with ESG and then picking stocks that are good ESG . The structured portfolio that I have takes me in a direction that may be consistent with that .

So my portfolio is probably okay on ENG , but maybe less so on S .

I also look at short interest ratio that's the degree of interest by short sellers in stocks , and banks don't do great on that criterion . And also I look at how well employees rate their companies , because that's a measure of how well maybe those companies are governed .

And typically , with a few exceptions , very few exceptions banks don't really do all that great on these corporate employee ratings . So yeah , that's why banks don't show up in my portfolio .

And the problem with as we discussed the problem with folks who provide investment products that are related to ESG are trying to sell standardized products to the thousands and millions of investors who all have different views as to what is preferable or objectionable from a moral standpoint in portfolio .

So ESG doesn't really meet the kinds of criteria that say a socially responsible investor who has very specific ideas as to what they want or don't want . Just ESG doesn't you know sort of fit that mold . So that's what I would , that's how I would answer that .

I think that also it's challenging , for it's challenging for somebody who isn't in the weeds on particular stocks to really understand how ESG actually applies to those particular stocks . So , basically , don't think of ESG as something that solves your problems regarding your issues regarding you know whether stocks are morally objectionable or morally preferable .

Don't think of ESG as something that reduces your risks or increases your returns , necessarily , but do think of ESG stocks that are high ESG as something that might provide a little bit more disclosure into the kinds of things that might create lawsuits and other things .