Last year I switched from MSCI World Index to MSCI World Custom ESG* Index. With passive investment you want as much companies as possible in your basket so excluding companies is not something to take lightly. But both these indices perform the same so for me it was an easy choice.
* Environment Sustainable Governance. 58 out of 1660 companies are excluded, mainly in tobacco, guns and UN global impact.
Does this actually make a diffence, from game-theoretical perspective? It seems to me that if substantial amount of investors start to bias in a certain direction, it will only create an opportunity for active investors to earn money by betting in the other direction, and these active investors will "fix" the "bad" price. Maybe it's not a coincidence those indices perform as well as the rest of the market, as you observed?
These active investors don't even have to realize their strategy is based on going against nice guys -- they might be led purely by statistical performance.
I'm not trying to be needlessly cynical. I like effective altruism for example. I'm just not sure stock market is a good battleground for ethics.
I don't disagree with his thought experiement/model.
Quite ironic though. Only five years ago I doubt Cliff would have invested time in thinking about this (I did work for him). The fact that AQR is paying attention and feels the need to express themselves on the topic speaks volumes.
There is research suggesting that "sin" or "vice" stocks outperform, as many people refuse to touch them, therefor creating an artificially lower demand which corrects itself by those who don't have the ethical dilemmas being able to pick up greater amounts of undervalued shares.
It depends if the people are betting that climate change is real and these companies will start to be treated differently are correct. Could be another 4 years before changes happen...
I agree. If a smart investor notices that a company business model stops working the moment governments pass legislation introducing carbon markets, it's a good investment strategy to short the stock. But notice that it's the government that is doing the heavy lifting here, investors are just diligently passing the shock from the future so resources are not wasted.
If there is a climate catastrophe going to happen, but no government is going to punish companies responsible, it won't make sense to try to do that for yourself -- in the same way bad corporations are freeriding on climate, bad investors are freeriding on your efforts to punish such corporations.
We are beyond that point. Climate change is real - I think most sophisticated investors have done enough due-diligence to come to that conclusion, despite all the uncertainties.
Investors and traders eat uncertainty for breakfast, lunch and dinner. It doesn’t stop them from making trading decisions. It’s what keeps market ticking.
By choosing the ethical investment you are in a sense becoming an active investor betting against none ethical investments.
Trying to reason about whether the stock market is a good battleground. If you know I wouldn't want to buy your investment, surely that lowers how much you'd value it, as does the potential for having to pay a premium on bonds. As a CEO your share based compensation starts to look less attractive as does the whole idea of presiding over a company potentially on the wrong did of history. So I wouldn't say its a pointless battle.
Lets take Uber, on one level its worth billions, but it makes no money, if everyone avoided the stock and debt it would run into problems pretty quickly. It is worth billions only because sufficient people believe it is/ will be worth that much, if enough people avoid it, it isn't going to be worth that.
I would say the bigger problem is that everyone has different ethics and what makes a company evil.
When you get to the level of those companies, surely they're going to do something evil. I'm not even sure what you're referring to with Nestle (baby milk?).
Id prefer to have it based on something more solid like carbon intensity or no oil or something actually measurable by us and the offending companies, rather than nebulous 'ethics'.
It's not causing climate change, though. That's saying nothing of their ethics, or how the impact their activities are having particularly with the accelerating climate emergency, but it's a matter of critical focus that we stop CO2 emissions, not divest companies that are unethical (admirable, but entirely separate).
For what it's worth, that is precisely how this effort will be gaslit. Divide and conquer.
Gaslighting is where an abuser says and does unexpected things that make the abused doubt their perceptions and sanity. I learned about it in film class in college. Suddenly people are using the term to describe all sorts of actions that don’t seem to fit that mold (but that involve some sort of ill intent). What gives?
I think it's interesting that an environmentally focused fund would exclude tobacco and guns, since neither have anything to do with the environment. That seems more like a partisan political statement/motivation than a focus on environment.
I'd go a step further and point out that this fund holds Nestle and Exxon... So it's not really even worried about environmental concerns, it's purely a political statement.
Ah, well that helps explain their motivations. It is a bit odd though that they are still holding major companies that have significant negative environmental and social impacts though. At some level, it's just virtue signalling with no meat. Either you care enough to divest your holdings in significant polluters, or you don't.
This makes me wonder: How hard would it be for companies to offer slightly customized funds? For example if I wanted to invest in S&P500 minus XOM. I might need to pay higher fees, but it's probably doable.
(The reason I want that is partly boycotting environmentally unfriendly companies, partly a belief that they will not grow anymore, for the reasons mentioned in the article.)
If you read this carefully it isn't that these financiers have grown a conscience, it's that public protest and the possibility of government policy changes have made it risky to hold these securities.
These analysts wouldn't have a rigorous analysis that made sense in financial terms without the force of public pressure. These companies are just machines that respond to stimuli and have no thought of consequences.
There may also be risk in future liability. Tobacco took a hit because they knew of risks but they continued to sell their products without warning customers. I have heard there is similar evidence for oil companies that knew of global warming long ago but have yet to warn their customers.
Totally disagree. In fact, institutional investors have for a long time resisted ESG considérations, and those who have adopted sustainable or responsible investment guidelines do so after a pretty thorough analysis of the investment risk/return impacts - understanding full well the potential impact on returns and communicating the implications to their stakeholders (pensioners, plan members).
I'm not sure what you're saying sounds like a total disagreement, but could you link to a few that did take into account ESG? Oftentimes, I find that when there seem to be exceptions to the rule, on closer inspection, there is something important about them that makes clear why they were able to do it.
It's similar, it's just that groups (esp. those focused on resource accumulation) are less moral than individuals. Whereas individuals might have ethics, dreams, a different way of thinking about the world, companies are tightly constrained in how they act without a stick beating them.
For example, all these CEOs I'm sure know about climate change and might even feel despair about it (or believe we'll invent some carbon capture tech, or believe they'll be fine in a bunker in New Zealand because they're rich). However, imagine being a big executive that would have to make decisions contra the interests of their investors. The institutional pressures would make it near impossible, and if they resign in protest, they'll simply be replaced with an ideologically correct replacement.
So you can see, individual hopes and dreams are ground up by institutional mechanisms, making the comparison not very straight forward.
This is something which has been trending up for the past 5 to 10 years, and gaining more momentum. Large European fund managers (e.g. pension plans) have been at the forefront of responsible investing and it is developing quickly amongst their peers in North America.
Simply put there are 3 dimensions which corporates have to consider:
1. Their contribution to greenhouse gas emissions and other environmental pollutants.
2. Their own exposure to physical climate risk (can they quantify it?)
3. Their compliance to reporting standards and regulations regarding climate change and other environmental issues.
Large investors increasingly want to know (a) how they contribute to climate change via their investments and (b) their risk exposure to climate change risk, via the businesses they are invested in.
Corporations have to realize that their large, institutional, investors are way beyond debating climate change and are taking action. Like it or not.
And I’ll add that corporates can take action to tackle all three dimensions:
1. Reduce emissions by adopting new processes and technologies
2. Look at innovative ways to hedge their climate/weather risk exposure (yes, it is possible, just like you can hedge currency or jet-fuel volatility risk)
3. Voluntarily get engaged in reporting to investors and engaging them before they engage you.
Even if a corporate is a significant greenhouse gas emitter, being pro-active and taking real action is way better than ignoring the issue. Investors are getting quite sophisticated in their understanding of climate issues and want to see material action.
>Corporations have to realize that their large, institutional, investors are way beyond debating climate change and are taking action. Like it or not.
I'll preface this by stating that I'm no subscriber to "corporations only care about profits" school, but:
Do you think this matters to the corporations all that much? You can't "dump" stocks without someone else buying the shares from you. Are these institutional investors going to take a huge hit in the name of climate change? Are the shareholders willing to sacrifice a chunk of their retirement for this cause? I'm skeptical. Where are the alternative investments? The world is awash in capital, with a huge chunk of bonds now paying negative interest rates.
The big risk is government regulation, but we haven't seen a whole lot yet.
> "You can't dump stocks without someone else buying the shares from you."
At what price?
That's the impact of moves like this: 1) lowering stock prices for existing companies and 2) allocating money/increasing prices for climate-friendlier companies. It could mean the difference between, say, a large oil company getting $1 billion from a European fund and a battery technology company getting that billion.
My point exactly. I know that executive pay is most often tied to share price, but who do you think really suffers more: the CEO who gets a slightly smaller bonus, or the fund that has to dump shares for whatever it can get?
Look at the example in the article. The fund dumped $300MM of Exxon shares in June, share price mostly unaffected.
>It could mean the difference between, say, a large oil company getting $1 billion from a European fund and a battery technology company getting that billion.
But unless the company is issuing new shares, it doesn't receive any of the money. It's a transaction between old/new shareholders.
I can see the drive to be able to market your investment fund as climate friendly to attract more AUM, but it's unclear to me it makes financial sense as the investor (at least generally).
You're not wrong. I'm interpreting it more from the asset manager's perspective than the company's. You're correct in that they are making a conscious choice to maybe forgo a profit on oil in order to bet on something more speculative. That's just the thesis they are going with and may adversely effect performance.
Yes, good point. Large investors (pension funds being the big ones) have, for many years, struggled internally with this. After all, their job is to generate financial returns. Period. However, stakeholders (i.e. their members) have been putting on pressure for the managers to take into account environmental, social and governance impacts.
I think there is increased recognition that we are entering a stage where real, physical, climate risks are becoming more obvious and both managers and their constituents are realizing that the long-term cost of inaction will overshadow the short-term pain (if any) of staying out of certain investments.
But yes, at the end of the day, large investors do have to prioritize return generation. Luckily, investment opportunities and new sectors evolve and there are ample new areas for investors to look at.
>However, stakeholders (i.e. their members) have been putting on pressure for the managers to take into account environmental, social and governance impacts.
I agree, and have no doubt that the funds benefit from catering to their clients demands. I'm less certain about the investors (and planet).
The stock market is a resource allocation tool, and this is shareholders saying they expect the future expected dividends of environmentally unfriendly companies to be lower than previously expected.
>and this is shareholders saying they expect the future expected dividends of environmentally unfriendly companies to be lower than previously expected.
And on the other end it's new shareholders (buyers) saying they expect the dividends of environmentally unfriendly companies to be higher than previously expected. How does it net out?
Unsustainability is unsustainability. At the scale of climate change it's no longer "we'll prosper at the cost of others", it's "we'll prosper in the short term at the cost of everyone - including ourselves - in the long-term". Finance people are apparently better than executives at thinking long-term (or maybe just have more incentives to care about the long-term, whereas CEOs can generate some quick growth and then peace-out).
I doubt it's about backing beliefs and principles with money. It's probably more about admitting increased risks of losing money as a result of public shaming campaigns (sometimes reasonable, sometimes not) by vocal minority.
And of course, the corporate PR disguises such dumping stocks as a virtue.
I dont quite agree. While this is certainly a secondary factor, which a portfolio manager will worry about (i.e. a stock tanking due to bad press or negative ESG ranking), investment committees which develop responsible investing policies are guided by guenuine principles. It’s a multi-dimensional problem and the challenge is of course that these dimensions sometimes counter each-other and result in feedback loops. The is what makes a market, however, the sheer size of large institutional (and sovereign) investment funds will, in the long run, run over marginal players in terms of impact.
in 2007 USA there were a half-dozen "major" frameworks for reporting risk and establishing a profile of a company; many professional papers and presentations. This sort of business-press cheer leading is necessary but insufficient.
Yes that’s true. And of course the banks have seen the ESG market as an opportunity to make a quick buck, and continue to generate report upon report. Also, many data vendors out there inventing all sorts of ESG metrics, many of which are of dubious significance. It’s a net positive though.
Ethical considerations aside, one of the other drivers of this is the origin of some of the money involved here. Most of the largest sovereign wealth funds globally are the result of money generated by resource extraction: Norway, Abu Dhabi, Kuwait, Saudi Arabia (directly and via Aramco), Qatar, etc. For these names, holding stocks that pose a climate risk is buying oil with oil dollars. Without intentional divestment of oil, coal, and other climate names, they are essentially levered long. Excluding these from their holdings is just prudent investment.
This has been going on for a few years. The Rockefellers sold theirs in 2014. They tried to make it seem like it was environmentally motivated but really, it was all about the money. [1]
Ideally, in time without policy changes or major government intervention, fossil fuels or business practices that willingly pollute and damage the environment will become uncompetitive and too expensive to make money.
If only we can find a way to bankrupt the palm oil farmers and loggers who are cutting down the Amazon Rain Forest...
Bloomberg used to me a good publication now its tied to hip to its founder's ideology. Him being a politician with Presidential aspirations, Bloomberg has taken a turn for worse. Divestment is not going to "clean-up" the environment. Its a tool of "do something" or virtue signaling crowd. Unfortunately, Mr. Bloomberg has a fortune to make investments in hard-science and safer power generation -- but it won't provide bang for the buck for his Political ambitions.
All we are getting from this disinvestment crowd is corporate green-washing as if we do not have enough of it.
One of the hallmarks of a collapsing society is that "everything becomes a political statement". The newspaper you read is a political choice, as does the sneakers you wear, and where you eat for lunch.
Sorry guys, for me this is a solid advice to increase my positions in oil, coal and nuclear ETFs. Especially if their prices drop a little.
Not that I don't care about the environment, I just don't believe that economy works "by design". We don't have better energy sources, and while this lasts, these will be profitable and expensive.
That’s a totally legit position - the hope is that incumbents in these sectors will adapt and work to clean-up their operations. I don’t think any investor, no matter how large, is aiming to kill these types of companies - but institute positive change. Having said all this, positive returns should come first.
* Environment Sustainable Governance. 58 out of 1660 companies are excluded, mainly in tobacco, guns and UN global impact.