Hi! Welcome to another edition of Climate Focus. The regular readers here know that I reserve my warmest welcome for the new subscribers over the past week.
Take warmth and fuzziness, new subscribers!
Today’s edition steps out of the proverbial ‘there are two sides to a coin’ and focuses only on the coin.
What is the coin, you ask? It’s the trillions of dollars in ‘green capital’ and how a lack of standardisation and regulations mean there is (laughably) a bubble in sustainable investing.
A bubble. In clean capital. I know, right?
Read on.
The G in ESG stands for gimmick?
“It’s good that more people are talking about ESG. But if you look at how some money managers determine if a company is socially responsible, it’s not very rigorous and they’re not really strict in their criteria. We have a lot of money coming in and they use ESG as a marketing tactic.”
This is a direct quote from Jerome Dodson of Parnassus Investments. He is by no means as popular as Larry Fink, the CEO of BlackRock, who is widely perceived as the messiah of sustainable investing (his recent Annual Shareholder Letter and its ensuing controversy not withstanding).
But Jerome Dodson ran Parnassus Investments, the biggest money manager exclusively handling ESG funds, from 1984 till October of last year.
ESG 101: Environmental, social, and governance (ESG) criteria are a set of standards for a company’s operations that socially conscious investors use to screen potential investments. Environmental criteria consider how a company performs as a steward of nature. Social criteria examine how it manages relationships with employees, suppliers, customers, and the communities where it operates. Governance deals with a company’s leadership, executive pay, audits, internal controls, and shareholder rights.
To Parnassus’ credit, they manage five mutual funds, with zero exposure to fossil fuels and ~ $48 billion in assets.
I wouldn’t fault you if you were to wonder what’s so spectacular about an ESG fund with no fossil fuel exposure.
But …
According to an analysis conducted in June 2020, around 83 percent of equity exchange traded funds (ETFs) presented as being sustainable had some exposure to fossil fuels.
and …
[…] alleged shortcomings in the ESG funds of some of the world’s largest asset managers, including UBS Group AG and BlackRock, Inc., whose CEO Larry Fink has promised to put sustainability at the core of how the company invests. It claimed some climate-themed funds had holdings in the fossil-fuel industry, including a BlackRock “fossil fuel screened” fund, and a State Street Corporation “fossil fuel reserves free” fund, which held shares in Marathon Petroleum and Phillips 66—”two of the world’s most egregious fossil fuel lobbying companies preventing policy-based climate action, according to InfluenceMap’s research on corporate lobbying on climate change policy.”
What’s surprising to me is that the biggest money manager of pure play ESG funds handled ~$48 billion of a $2 trillion ESG market. In other words, 2.4% (eek!)
The $2 trillion is based on a narrower definition of what qualifies as ESG funds. Some estimates that park the figure at $35 trillion.
All said and done, ESG is an asset class - a very specific type of investment. It is (relatively) new and is growing very fast. The short history of organised financial markets is chequered with numerous instances of freshly minted asset classes shining bright, but fizzling fast. We can’t allow that to happen with ESG. The amount of money flowing into ESG funds is staggeringly high and a general lack of transparency and regulation is making sound people nervous.
(SRI stands for Socially Responsible Investments)
The risk is playing out in specific scenarios.
For instance, US ESG funds are likely to face collateral damage because these funds have a high exposure to technology stocks. The interest rate hikes by the Federal Reserve this week have been particularly brutal on tech bros.
Another unwanted consequence is that some clean energy stocks (the OG-ESG, if I may) are trading at unrealistically high valuations. So much so that hedge funds hold ‘short’ positions (betting that prices will drop for these funds to make money) on sustainable stocks. The reason: consistent investments from ethically minded investors over the last couple of years.
Ethics is good. Investing capital behind that is awesome as well. It is time to be a bit more discerning with both, specifically with what counts as ethical.
To clarify my position, I am not arguing that companies shouldn’t invest in fossil fuels or non-green energy sources. I do think they have a role to play to enable a sustained transition to cleaner sources of fuel. And in all fairness, there is room within the definition of ESG to include fossil fuel companies in a ‘sustainable’ portfolio.
But there should be a means to separate the good apples from the bad ones - the ones that are putting their hand up and working towards reducing their emissions and the ones that are ‘greenwashing’.
This needs to be fixed.
Oh and most certainly, ESG funds shouldn’t include sectors only to ensure financial performance and the hand-me-down secondary risks because of that. ESG has enough risks just on its own.
To close this out, Bloomberg clocked 300 mentions of ESG in earnings call transcripts of energy companies in a single quarter last year. The figure can be interpreted in many ways, and most will be of the pessimistic persuasion.
Mine is not. I am trying to be a better human being than that.
I am going to say that it is difficult for oil and gas companies to continue to operate per-usual without taking corrective action on their ESG agenda. That is because the world around them is changing and more people, including their direct stakeholders, care enough to act on it.
I am going to say we will experience a marked improvement in ESG performance this year onwards.
I think Amy has this sentiment nailed down.
“I think you start small and then scale up over time. From what I’m hearing in the market and from private equity, there’s not an expectation of perfection in year one but rather the expectation is that companies are engaging in the issues and showing progress over time.”
Amy Stutzman, Managing Director of Opportune, a leading global energy business advisory
The only thing that will be left to do is greater transparency, compliance, and a standardised process that will differentiate intent from action, and the measure the latter as accurately as possible.
Bonus
— The (High) Price of Carbon
(This one makes me personally happy)
— Nothing to watch here. Just China doing China things.
— And India can (100 GW) flex too
Banter
— Big Corporations suddenly find themselves in the Matrix
(Side bar - How did you like the new Matrix movie? Someone told me that you have to see it for yourself just to know how terrible it is. I was never the same after that).