ESG Investing: An Alternative View

The CFA Institute is keen to transcend the axiomatic and empirical to enter the realm of the metaphysical. I refer to the realm of the squishy, the malleable, the protean, the fuel of the horribly political. I refer to Environmental, Social, and Governance (ESG) investing.

The CFA Institute attempts to floodlight the journey. The powers that be who collect our annual fee have produced a guide for us members to ponder when our philosophizing and marketing (marketing, for sure) turn to ESG.

But what are pondering? We kinda know, but we don’t really kinda know, what it is. I suppose ESG can be likened to pornography, or rather Supreme Court Justice Stewart Potter's stumbling attempt to define pornography. Words failed him on a definition, so an alert staff law clerk contrived an out: “Mr. Justice, you will know it when you see.”

Justice Potter may have had an easier time of it than the CFA Institute. The wind blows through the guide’s vague wording like a Nor'easter’ blows through the Mid-Atlantic states in mid-February. You know the words, but the meanings less so: “biodiversity,” “climate change,” “human rights,” “gender and diversity,” “board composition,” “executive compensation.” You get the picture, or you would if the issues were stated in words that conjured solid images.

Numbers conjure solid images, but only the right numbers conjure the right images, and if they are conjured only the right way. Big numbers gathered from vast landscapes are conjured the wrong way. The big aggregated and averaged numbers we so frequently encounter tell us nothing about any particular situation, or whether the number is even relevant to any particular situation. ESG, it seems to me, is anchored to big numbers.

When the big numbers say six percent of the S&P 500 companies can boast of female CEOs or that fifty percent of Silicon Valley employees are Asian, what should we make of it? Relative to another big aggregated number, one might infer something is amiss. Women constitute over fifty percent of the U.S. population, but why should we extrapolate that percentage to infer they should constitute more than six percent of the CEOs of S&P 500 companies? The same is true for Asians employed in Silicon Valley. They constitute six percent of the U.S. population, but fifty percent of the Silicon Valley worker population.

Six percent, fifty percent: who derives value from these averaged and aggregated numbers? Someone must, or why produce them?

Social justice advocates, busybodies, do-gooders, megalomaniacs, habitual worriers, conspiracy theorist are ready consumers of big aggregated numbers. In other words, the typical band of brigands too eager to implement an agenda and too impatient to persuade others with logic on the agenda’s value. They prefer the road easier to travel: state-sponsored coercion.

These big, aggregated numbers are most treasured by economists. And who is the largest employer of economists? The federal government. Who is the second largest employer? The Federal Reserve.

Economists working on the federal dime (and I include the Federal Reserve economists) are the support staff of the political class, composed mostly of the impatient, interventionist class (the band of brigands). For what politician isn’t compelled by the urge “to do something” and to do it now? Economists collecting, aggregating, and averaging data into one easily retrieved number provide support for the doing and doing it now.

The beauty of relatively free, non-coercive markets is they are relatively competitive. Businesses compete for factors of production, and that includes employees. How they combine these factors to produce goods and services most efficiency to satisfy consumer demand matters. We, as financial analysts, can measure performance by vetting the financial statements. These are the numbers that matter if they are presented truthfully. They are the only way to measure corporate governance.

A profit is proof that value has been created on both sides of the transaction. A profit implies a respectable degree of efficiency. We like to see continual improvement in margins, which points to improving efficiency, the byproduct of less waste (less negative externality) and better organization of production factors. Inefficiency and waste drag on margins, they drag on profits.

A profitable company must respond not only to consumer needs, but to employee needs. Turnover is expensive, it implies an inefficient culture, one possibly antithetical to that held by its employees and society in general. Low employee turnover is an outgrowth of an accommodating, productive culture. It is the outgrowth of an amenable work environment and a salary and compensation structure deemed fair.

If employees are valued for incidental characteristics, but are production-deficient employees, the bottom line suffers. Companies are unable to value incidentals over productivity. Institutionalized racism is a luxury few companies can afford. Free markets and competition lead to color blindness and gender neutrality because the bottom line matters most to the owners.

I suppose a company can project a warm, cuddly image if its requisite returns on capital are achieved by an employee rooster that resembles a United Colors of Benetton advertisement. If the United Colors concept reigns supreme, with all else slotted below, you can be sure discontent will follow. You hire your plumber, your electrician, your landscaper based on his or her productivity. If it so happens that a monochrome hue correlates with the productivity you demand, does it matter? Why should it be different for a Fortune 500 company or a 10-person LLC?

What about the individual? What is his or her role in achieving ESG equilibrium?

If you want to promote diversity, improve yourself. Be willing to adjust to the cultural norms. Every sale occurs because it satisfies the buyer’s demands. The employer is the buyer. Speak grammatically correct English. If you say “me and him” when you should say “he and I,” should we resent the employer, who, when vetting two equally skilled candidate, sides with the one more literate? A neck tattoo versus no-neck tattoo, a blazer and dress slacks versus a t-shirt and jeans? Who would you hire when the skills are comparable? What does the culture of the industry dictate? Know that. The more professional you appear, physically and intellectually, relative to the competition, the more likely you will be hired. Most important, go in knowing that you can perform the job to the employer’s standards.

And cultural norms in a free society evolve. They mostly evolve to favor civility. Consider the casual callousness in which slurs were directed toward minorities of all sorts only a few decades ago. Think of the subservient, sexual stereotyping of women in 1950s and 1960s advertising. The West has undergone a moral advancement as stunning as its material advancement.

As for the giant “E” in ESG.

For good or bad, I have been blessed with a long memory. That memory extends to the early 1970s. (I’m 58 years old.) Population growth was the climate change of the day. The earth, the scientists told us, groaned under the weight of its four billion human inhabitants. The decisive straw was about to break the camel’s back. We were doomed.

Hyperbole on my part? Hardly. Consider this slice of apocalyptic prophesy from Paul Ehrlich, a former Stanford University biologist, in his bestseller The Population Bomb: “The battle to feed all humanity is over. In the 1970s hundreds of millions of people will starve to death in spite of any crash programs embarked upon now. At this late date nothing can prevent a substantial increase in the world death rate.” So, according to Ehrlich fifty years ago, there is nothing to be done, because we’re done as a species.

Now, imagine that you were a money manager infused with a tinge more optimism than Prof. Ehrlich. What companies would qualify as an ESG-approved investment under Ehrlich’s scenario? I would aver pharmaceutical companies that produced contraceptions, armaments for national militaries, cigarettes, booze, junk food. Any company that prevented a new human from entering the world and any company that caused more humans to exit sooner than later.

And yet here we sit fifty years and three-and-a-half billion people more later. Mass obesity has supplemented mass starvation as the overarching problem humans face related to their eating habits. Many of us apparently do little more than sit.

The 1970s were rife with phobias. Population was one, climate was another, except back in the days of bell-bottom blue jeans and ragamuffin haircuts, pearls were being clutched over the prospect of a freezing planet. Do something, for goodness sake. Do whatever the something the scientists were demanding at the time -- catastrophe awaited. We would slide into a new ice age. When? Of course, forty or fifty years forward, so about now.

But why do anything to reverse the slide into new ice age? What good would it do if we could do little more than squat in mud huts?

We, the humans, the scientists told us, were exhausting the earth’s natural (carbon) resources. Depletion of oil was of grave concern (again). Fossil fuels were destined to follow their reptilian source into oblivion. The scientists warned in 1972 that the United States could be depleted of oil within the next twenty years (depleted nearly thirty years ago from today).

Here we are, or here we sit, with wide bottoms lapping over our seat, fifty years hence. The upstream exploration companies seem to discover oil with the ease of Jed Clampett firing a bullet into the side of a hill. Texas “tea” is as ubiquitous as herbal tea.

Ehrlich was wrong on population, which is par for his course. His history is peppered with spectacularly wrong catastrophizing. He never quite learned to quit when he was behind. I will extend props to our chicken-little professor on one matter, though: He at least was willing to expose some skin to the game.

In 1980, business professor Julian Simon at the University of Maryland challenged Ehrlich to choose any commodity he wanted and a date more than a year away. Simon would wager on the inflation-adjusted price of each commodity decreasing over the period. Ehrlich chose copper, chromium, nickel, tin, and tungsten. The bet was formalized on Sept 29, 1980, with Sept. 29, 1990 as the payoff date. Ehrlich lost the bet, as the price of all five commodities declined over the ensuing decade.

When the greens couldn’t bend us to their will on scarcity, they poked around for a new bogeyman. They returned to the garbage dump of manufactured hysteria – the climate.

One side, the winning side at the moment, claims we must act now to alter the rate of change. Climate change, an encompassing term invoked after global cooling, the scare of the 1980s, failed to materialize and after global warming, the scare of the 1990s, failed to maintain its purported cataclysmic rise.

Yes, the science is settled on climate change – the climate changes. It always has, it always will. We humans likely contribute, but the degree of our contribution is far from settled. Your view from your side of the political aisle colors your view as it colors mine. You call forth Michael Mann, I’ll call forth Fred Singer. You give me Al Gore, I’ll give you Freeman Dyson. The science is far from settled on the matter.

I refuse to reflexively defer to the white-smocked scientist as a Catholic might defer to the white-collared cleric. A scientist is a member of what the Polish philosopher of science Ludwik Fleck labeled a “thought collective”. The collective, suggested Fleck, inevitably develops a mind of its own, as the individuals in it harmonize on communicating, thinking, and feeling. Their inescapable humanity ensures that scientific inquiry is subjected to the eternal rules of human social life: deference to the charismatic, herding toward consensus, a reluctance to admit errors.

Ah, but guess what? Admitting error ensures a harsh rebuke. The heretic must be ridiculed and marginalized. You see it in the terminology applied to those who deviate. “Climate change denier” is the lead invective hurled at those who question the consensus-derived extent of human contribution to climate change. Never mind that the heretics don’t deny the climate is changing. They don’t even deny that humans contribute to the change. They annoyingly question the dire apocalyptic prognostications.

How do the ESG votaries wish to lead us into the future? By embracing the past.
Electricity, wind, and solar are at the forefront of the “E” in ESG. The promise of the battery-powered electric car is nothing new. News outlets have hyped the potential of electric cars for at least the past century. As for wind, the Dutch have employed windmills since the thirteenth century. The sun? Humans have relied on it as an energy source since the seventh century BCE, and likely before.

Retrograde, that is what it is, and yet no group has promoted electricity, wind, and solar as much as the progressive political class. They have backed their support with taxpayer money through tax credits, subsidies, and guaranteed financing like no other sectors. They have run interference for these privileged groups with regulation and legislation that raises the cost of traditional (and very abundant) fossil fuels. Thermal coal, most notably, is being regulated and legislated to the point of irrelevance in the United States, not because it is inefficient, mind you, but because it is anathema to a specific agenda.

Few seem to notice that the ESG-approved energy sources consume huge swathes of another limited resource – the earth’s surface, namely real estate. They consume far, far more real estate for the equivalent amount of electricity produced than nuclear, natural gas, or coal-fired power plants. Indeed, driving through Kansas east of Salinas on I-70 one will see mile after mile after mile of huge, imposing wind turbines. (Driving through this region on a scorching, breezeless July day, I saw not one blade spinning.) And not wisp of support for air-emissions-free nuclear. At least the technology is twentieth century.

Resources coerced to politically friendly environment projects are resources coerced from those on the outs politically. Who is to say that the resources used to promote politically friendly energy sources would not have produced more environmentally friendly outcomes had they not been plowed into further developing and refining these political repugnant, traditional energy sources?

The internal-combustion engine becomes more efficient through continual investment and evolving combustion technology and through continual investment by refiners to produce more efficient-burning fuel. Unfortunately, we lack a parallel universe to measure the counterfactuals. Who is to say the capital diverted to the putatively sustainable energy sources has only retarded the possibility of new, novel, efficient, clean energy sources materializing from the ether – a source that would supplant everything now known?

The internal-combustion engine is analog, the battery-powered EV is digital. The analog is mechanical. What is mechanical is rebuildable, it’s recyclable. What is digital is disposable. Which automobile will remain road-worthy one hundred years hence: a 1921 Model-T Ford or a 2021 Model 3 Tesla? My money is on the Ford. I see a Tesla, I see a 1970s LED watch (a sterile piece of virtue-signaling, disposable hardware): The Tesla is the 2021 equivalent of the 1994 Packard Bell 286 computer and the 2010 Blackberry cellphone.

Sustainability is ESG’s handmaiden. You tell me what is sustainable. I know your mind wonders to the physical: resources extracted from the earth. Continual extractions from the earth are exhaustive. The extractions are unsustainable, except they are sustainable. The evidence tells us so.

The transcendental enclaves of the human mind is where “sustainability” resides. It is human ingenuity. If humans are permitted to improvise, adapt, profit; if we are able to pursue our innate desire for efficiency – to continuously do more the less; if we respect and enforce property rights, there is no need to worry about “sustainability” or manufacture phony concepts of sustainability. We can adapt. We will adapt. We will do more with less. We’ll clean the joint up along the away. That is our history.

But if time were only on our side. The friends of ESG assert time is the enemy. We must act now to stem the rise of anthropogenic carbon emissions, lest the Empire State Building stand waist-deep in Atlantic ocean.

History has proven it simply is not so, but let us assume it is. Who is to say it is less efficient to simply adapt? In the meantime, we run efficiently as we can with the knowledge and technology we have, while continuously adding to our efficiency, knowledge, and technology The Dutch have proven humans are capable of adapting and earning a buck at the same time. (Twenty-seven percent of the Netherlands is below sea level.)

My concept of what constitutes an ESG company differs from your concept. I argue that Exxon Mobil is ESG worthy. If you are willing to look past the tailpipe to full benefits versus costs, why am I wrong?

Exxon Mobil delivers products its customers want, at a price they will pay. Its products – directly and indirectly – are inputs to nearly every product in your life.
Exxon Mobil understands and caters to its shareholder constituency. The dividend matters to its shareholders, particularly to those in their Buick-driving years, of which there are many. It has mattered for the past one-hundred-ten years. (Full disclosure: I am an Exxon Mobil shareholder who values the dividend.)

Exxon Mobil has relentlessly grown profits and dividends over the past century by attracting able, motivated employees (through generous salary and fringe benefits). ExxonMobil has a long reputation as the best-run energy company among the integrated giants.

Culture must be considered an overarching variable in Exxon Mobil’s century-long success. I see a culture that has evolved to favor wisdom over cleverness. Wisdom being the byproduct of long-term thinking. Wisdom attempts to discern consumer demand years and decades into the future. Wisdom means investing now to meet those future demands, to generate future profits, to continually grow the dividend. Wisdom is attuned to reality, as opposed to fantasy and wishful thinking and political expediency. Exxon Mobil management asserts that fossil fuels are the future. I agree.

Cleverness, in contrast, favors expediency. Cleverness is about the moment, shoving a penny into a fuse slot when a fuse continually blows. That is clever. Wisdom is sourcing the cause through a meticulous, reputable mechanic and repairing the cause. The first is an expedient solution. The second is the expensive and time-consuming solution. It is also the efficient, permanent solution.

I see the young egotists at Engine No. 1 agitating for a board change at Exxon Mobil as clever. They use the words of the trendy vernacular when they agitate for change. They boast of an “emerging view of value creation.” They believe companies need to “invest in their stakeholders” (And the stakeholders? Anyone who so declares himself one.) As for hands-on, daily-grind, big-oil experience at Engine No. 1, I don’t see any. How can they be wise? I want nothing to do with them.

Something, someday will displace fossil fuels as our primary energy source. And whatever energy source emerges, its sustainability will be assured only by economics, not politics, which means the energy source will arrive with no free lunch. Every energy source requires something, either chemicals or materials, that must be exacted from the earth and re-purposed for our use. Windmills require steel and fiberglass, which require energy to produce, and plastics to coat the wires. Solar panels require metals and rare-earth minerals. Both require chemically saturated batteries.

So, what is ESG investing anyway?

I see ESG as nothing more than a clever marking euphemism for large-cap growth-fund investing. The self-styled ESG funds I vetted were front-loaded with the usual top-ten, large-cap growth names: Apple, Microsoft, Amazon, Google, Tesla, Visa (or Mastercard). I’ll put it to you: What makes Apple, with its throw-away-every-two-years iPhones, more ESG-compliant than Exxon Mobil?

And please, look past the tailpipe before you answer. Channel your internal Bastiat and you will find Exxon Mobil is more ESG than you think. You will appreciate the ESG-bona fides of many companies perceived otherwise.