ESG (environment, social, and governance) funds are the hottest investments going. The only problem is that they are like free trade coffee — the consumer (investor) pays more for the same product. They might “feel good” in the process but their feelings are irrational because they are paying for a brand label rather than anything substantive. No subset of investors, after all, can permanently change the world through their preferences.
A recent study by Barclays shows that while one in four investment dollars are currently in mutual funds labeled ESG, most investors do not realize that those funds are virtually indistinguishable from non-ESG-labelled funds in terms of portfolio composition or returns. Only fees differ and, unsurprisingly, are considerably higher for ESG-labeled funds — on average almost 0.75 percent vs. less than 0.50 percent for non-ESG-labeled funds.
P.T. Barnum once claimed that there is a sucker born every minute but thanks to population growth and an increasingly complex world, it is closer today to every second. You’ve heard them in the supermarket: “Oh ma Gah, these eggs cost twice as much as those eggs but these ones are la tautly organic, tautly.”
Maybe some organic eggs are different but in an effort to stay at least six meters from others, for their safety of course, I accidentally saw empty crates of dollar per dozen bulk food club eggs suspiciously close to $4 per dozen “organic” eggs for sale at a roadside Jersey farm produce stand over the mild Thanksgiving holiday. “That’s a lot of eggs,” I said after returning to the front of the stand when the old people finally cleared, “Where are all the chickens?”
“Oh, we buy them from the farmer down the road,” the purveyor said.
“Uh-huh,” I responded, “you mean Sam’s … place off Berlin-Cross Keys Road?” a veiled reference to the Sam’s Club there. The icy stare and I assume bared teeth behind her mask meant it was time for this cowboy to mosey along, organic eggless and friendless.
Shouldn’t I have stayed and warned everyone about this egg arbitrage outfit? After all, we learned this summer that many on the Left believe that if you aren’t actively anti-fraud, you are pro-fraud. I agree, so beware those selling organic this and that as it may just be the same old product, made the same old way, but with a new label and at a special P.T. Barnum price.
But organic food fraud is small potatoes compared to ESG-labelled funds. If they charge just 0.25 percent higher fees for essentially nothing extra in return, irrational investors are gifting the fund managers big bucks, billions of extra fees per year in an industry with $18 trillion under management.
No, I do not think we need additional government regulation, I think we need investors (citizens, neighbors) who are rational and informed, who care about actual outcomes and not just feeling good through virtue signalling. It is no virtue, after all, to invest in something merely because it is labelled something that sounds or seems good.
The simple fact of the matter is that governments, not voluntary associations like corporations, cause most of the world’s problems and voluntary associations, not governments, could provide most of the solutions. If people really cared about the environment, for example, they would shrink the size of government and allow voluntary associations to do more.
Private ownership of land and animals is the surest way of promoting actual biodiversity. While some tracts may be ravaged for resources, many people care deeply about the environment and are happy to pay for the permanent preservation of habitat and animal species great and small.
Consider, for example, the Pennypack Trust, which for exactly 50 years has been preserving hundreds of acres of meadows and forest floodplains along Pennypack Creek just 15 miles north of Center City Philadelphia. How many more such local endeavors would have arisen if taxes were not so … robust?
“But,” you can almost hear the central planners retort, “some projects are too big for private initiative.” Maybe, but probably not. Consider the American Prairie Reserve, a Montana nonprofit bigger than some New England states dedicated to preserving massive swathes of the northern Great Plains shortgrass prairie ecosystem, from bison to prairie dogs and all the sundry delish types of vegetation they eat.
The APR’s success is due to the tight budget constraints it faces, not massive investments from governments or ESG investors. It buys or leases land strategically to connect islands of state and federal land to preserve or restore wildlife migration corridors and provide large, unbroken patches of habitat. It’s rational, i.e., sustainable, environmentalism at its finest and could be replicated the continent over if investors simply donated those extra ESG fees to market-based environmental groups. Unfortunately, as comedian George Carlin liked to remind us, most Americans are “stupid.” When they read “market-based” they think “greedy bastards” instead of “efficient,” even when only well-governed nonprofits are involved.
Of course nonprofits cannot meet all our desires, so for-profit investment has a role to play in the market-based environmental movement as well. Environmentally-conscious investors and fund managers seem not to realize that “profit maximization” is simply another way of saying “waste minimization.” That is a good thing, right? Don’t we all naturally want to invest in waste minimizing/profit maximizing companies anyway?
So what is ESG really about? I doubt anything substantive but, perhaps, someday ESG-labelled funds will actually be ESG funds, or in other words will meaningfully differentiate between ESG and “wicked” companies. But then, as the Financial Times recently pointed out, they will face a conundrum. To the extent ESG successfully diverts investment away from “wicked” companies, their share prices will decline, i.e., they will become inexpensive and hence set up to outperform so long as any subset of investors continues to maximize returns/minimize waste.
Meanwhile, the shares of ESG companies will get wicked expensive as more and more money piles into them. At that point, with the expectation of low returns on ESG and high ones on “wicked” stocks, virtue investors and ESG fund managers will have to eat palpably lower returns or creatively reclassify “wicked” companies to get higher performing stocks into their portfolios, i.e., destroy the meaningful differentiation between ESG and “wicked” companies once again.
Short of a completely command economy, “wicked” companies will always find investors willing to earn excess returns no matter how many ESG investors choose to continue to stew in low returns. After all, even truly wicked, illegal companies engaged in drug, gun, or human trafficking face few financing constraints. Law enforcement can run illegal businesses up the security market line (more risk but more reward) but can’t run them all off because their very success at forcing exit through incarceration creates market conditions conducive to new entrants.
In the end, then, the hip hop group Public Enemy was actually the investing public’s friend; when it comes to ESG, “Don’t Believe the Hype” because investors “Can’t Truss It.”