Why The Sustainable Investment Craze Is Flawed
The failed promise of funds guided by environmental, social and governance principles.
5 min
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The financial industry has spotted an opportunity to make money by helping people feel good about themselves. Despite claims to the contrary, these investments don’t do much to make the world a better place.
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.
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.
Sadly, selling off assets or shares by itself does nothing to save the planet, because someone else bought them. Just as much oil and coal is dug up and burned as before, under different ownership. And there are plenty of people out there to buy the assets, because never before in history has there been so much private capital operating without the public reporting requirements brought by stock markets.
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. The pitch from Wall Street fund managers is the exact opposite—that by going green investors can change the world and make more money, not less.
“A lot of [clients] only really get enthusiastic if they get comfortable that they are not sacrificing return,” says Valentijn van Nieuwenhuijzen, chief investment officer at fund manager NN IP, which is being bought by Goldman Sachs.
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.
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.
Some of the biggest sources of fossil fuels are immune to shareholder pressure anyway. Much of the world’s oil is pumped by government-controlled companies, led by Saudi Arabia and Russia. Exxon can be forced to change its approach, but the global supply of oil is still determined by OPEC, as President Biden’s appeal to the cartel to pump more to keep fuel prices down has demonstrated.
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.
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.
Otherwise profits can only be maintained by passing the higher costs through into higher prices, and—unless the firm has monopoly power—eventually customers who don’t care will go elsewhere. The alternative is to reduce profits, but ESG investors are almost universally against this.
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.
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.
Equally, if you think customers will be willing to pay more for brands that cut their carbon use, by all means, bet on their shares. Just don’t fool yourself that you are making much difference to the world with your investment decision. Red-blooded capitalists chase these profits just as much as any green-minded investor. There is no need to try to persuade capitalists to have a conscience; they will do what you want if you make it profitable via customer demands or government intervention (or, if we are lucky, new technology).
There is one way that ESG investing does, sort of, work. Shareholders can push companies to stop lobbying governments in favour of fossil fuels. Conceivably this might help push customers and governments to do the things that would really make a difference.
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.
Reprinted by permission of The Wall Street Journal, Copyright 2021 Dow Jones & Company. Inc. All Rights Reserved Worldwide. Original date of publication: January 23, 2022.
Chris Dixon, a partner who led the charge, says he has a ‘very long-term horizon’
Americans now think they need at least $1.25 million for retirement, a 20% increase from a year ago, according to a survey by Northwestern Mutual
Many people are spending more than they think as inflation stays elevated
3 min
Many people have a gap between what they think they spend and what they actually spend. This gap has widened recently as the financial and psychological effects of higher prices further strain people’s budgets.
Elevated inflation has rippled through American’s wallets for more than a year now. Some have cut back, while others have increased their spending to keep up. Credit-card balances were staying relatively flat for a while, but have jumped higher recently.
In the fourth quarter of 2022, the average household’s credit-card balance was $9,990, up 9% from in the fourth quarter of 2021, according to WalletHub, a consumer-finance website. Meanwhile, the average credit-card interest rate rose to a record high of about 20% last week, according to Bankrate.
Financial advisers say the larger amount of credit-card debt while rates are higher is one indication that some Americans are spending more than they think they are. This type of spending can reduce people’s ability to pay for important items down the road, such as college for a child or even fund their own retirement. More immediately, it will put people in costlier debt.
“If people spend too much on credit, they could end up trapped in a cycle of debt,” said Courtney Alev, consumer financial advocate at Credit Karma.
Spending less isn’t always possible when everything from groceries to travel is generally more expensive. Still, people can find ways to cut back if they understand more about why they are overspending and take a closer look at their finances.
Inflation on top of inflation
The power of compounding is a boon to investors, but not to shoppers.
Money grows much faster than most people expect because interest is earned on interest, said Michael Liersch, head of Wells Fargo & Co.’s advice and planning centre. A similar concept applies to inflation: Prices rise, and if inflation remains high, prices continue to grow on top of already-inflated prices, leaving people off guard.
“People get constantly surprised that their money isn’t going as far as they thought it would,” he said.
The cost of eating out and going for drinks continues to take Dina Lyon aback. Even though the 36-year-old married mother of one is dining out and ordering in far less than she did a year ago, some prices still give her sticker shock.
“The difference between cooking at home—about $10 for nice pasta and quick sauce from canned tomatoes—versus Italian takeout of $50 is astronomical,” said Ms. Lyon, who lives in Brooklyn, N.Y.
Outdated budgets
People tend to underestimate their future spending in large part because they base their predictions on typical expenses that come to mind easily, said Abigail Sussman, a professor of marketing at the University of Chicago Booth School of Business.
She and other researchers found that when people are coming up with predictions, they tend to think about what they usually spend money on—such as groceries, rent and gas—and base their predictions primarily on these expenses. They are less likely to consider atypical expenses, such as car repairs or birthday presents, the researchers found.
This pattern is particularly problematic when inflation is high, said Prof. Sussman. When the price of the same basket of items rises, people might not account for these price increases in their future budgets, she said.
Further, times of stress cause people to be less intentional about tracking their money, said Mr. Liersch. They might also spend more than they know they can afford to soothe feelings including anxiety and depression.
According to a recent survey by Credit Karma, 39% of Americans identify as emotional spenders (defined by the study as someone who spends money to cope with emotional highs and lows.)
Take control
You have a better chance of staying under budget if you become more aware of your spending instead of sticking your head in the sand, financial advisers said.
One thing Adam Alter, a professor of marketing at New York University’s Stern School of Business, does is create a line item in his monthly budget for one-off expenses, such as an unexpected medical bill. This gives him a cushion in his budget and enables him to more fully examine how much he is spending each month, said Prof. Alter, who has studied overspending.
People might also wish to include an escalating buffer into their budgets of say, 2% to 5% a year, to account for inflation, he said.
Jay Zigmont, a financial planner in Water Valley, Miss., looks at clients’ total take-home income from the year, subtracts everything they must spend money on such as their mortgage and how much they saved. The remaining number is how much they spent on discretionary spending.
In most cases, clients are surprised they spent so much, he said.
Once people know how much they spend, Britta Koepf, a financial planner in Independence, Ohio, suggests they practice mindful spending. Before any purchase, ask yourself if you really want or need what you are buying. Frequently, the answer is yes, but sometimes waiting five seconds will prevent you from overspending, she said.
You can also practice mindfulness by delaying purchases further.
“A lot of the time, if I tell myself that I will purchase it next week, I find that I am no longer interested a week later,” she said.
Following the devastation of recent flooding, experts are urging government intervention to drive the cessation of building in areas at risk.
