Some weeks ago, I saw my seven-year-old daughter watching "The Lorax," a movie based on Dr. Seuss' favorite children's book. Although the fable is ostensibly used to express Dr. Seuss' anger at corporate greed, I believe the story displays that greed and care of the environment can coincide with one another.
Seuss' character, the Once-ler, is depicted as a faceless green suit that in his greed and blindness destroys an entire ecosystem in order to create a product called a "Thneed". As the Once-ler cuts down all of the Truffula trees to make Thneeds, he destroys the environment in which the beautiful cartoon characters live and in turn, also drives his business into bankruptcy. Though the Once-ler made money in the short term, had he wanted to be profitable over the long term, he should have been a caretaker of the environment and responsibly cultivated the growth of the Truffula trees so as to not wind up telling a sad story among a barren land. Fortunately, one seed is saved and future businesses can learn from this tale.
Socially responsible investing (SRI) can be defined as an investment that is considered socially responsible because of the nature of the business the company conducts.[i]
I believe SRI is a grey, highly individualized area that purports to achieve the impossible: to determine that one company be deemed "good" with another "evil" based upon varied factors such as a few individuals, methodologies, operational procedures, business practices or the product(s) sold. Those who tout SRI and ESG (environmental, social, and governance) strategies are either disingenuous but understand it is a great marketing gimmick, or are simply clouded by their own biases, believing theirs is the "right" cause of action under which all investing decisions should flow.
To me, applying a prism of particular SRI or ESG filters is inconsistent with a fiduciary responsibility to achieve the best possible return for our clients. That said, I believe that companies which take a long-term approach and act ethically will best be able to create more sustainable and profitable businesses due to the trust they've built over time. Even a company that creates something which someone may deem as "evil" (possibly tobacco manufacturers or technology companies attempting to addict us to our screens), should be open and transparent about what they do in selling the product they are producing. As a money manager, my mandate is to provide the best risk-adjusted rate of return possible for our clients. Investment analysis requires tremendous amounts of study and experience to make a reasoned determination on whether or not to invest in a particular company. Adding the complexities of the percentage of green buildings, women in management and the board's diversity (not to mention which percentage is acceptable) pushes one into very grey determinants encumbered by complicated concepts.
"There is one and only one social responsibility of business - to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud."
As to whether or not socially responsible investing - or environmental, social, and governance - provides better returns, I believe the jury is still out. Those who purport that it does continue to promote it. Even those who may not have a direct skin in the game, such as professors at academic institutions, are likely biased by their viewpoints on such issues as climate change, diversity, consumer protection, animal welfare and the like.
Writing in Pension Management, author Jack Gray argues that "Boards spend excessive time on ESG relative to any expected benefits for the principals...or its potential to improve member's returns." Gray also holds that "ESG investors risk overpaying for the 'privilege' of owning them, almost regardless of price."[ii]
I agree with the author that most boards are ill-equipped to determine what companies are ESG friendly. Those that believe they can are either naïve or duplicitous. As he points out, executives are masters at "listening inactivity, a core competency they develop from explaining themselves to hordes of analysts and portfolio managers." This is why I don't waste my time listening to earnings calls wherein self-serving analysts, typically from the big investment banks, ask silly questions to which everyone knows the answers, or to make themselves sound important.
Writing on SRI for cbsnews.com, columnist Larry Swedroe notes that "SRI funds are typically more expensive than index funds and passive funds in general. One reason is that they incur the extra costs of screening out the undesirables. Those extra costs can hurt returns. SRI investors also typically sacrifice diversification as SRI funds are often domestic and large cap. Thus, investors sacrifice exposure to small-cap and value stocks, and perhaps international, and emerging market stocks as well. They also then lose exposure to the higher expected returns provided by small-cap, value, and emerging market stocks. SRI investors also may be accepting other risks. Because they avoid investing is "sin" stocks, they're not fully diversified across industries."[iii]
According to bizfluent.com, Corporate Social Responsibility (CSR) often requires changes to a number of processes, as well as increased reporting. In many cases, businesses hire additional personnel to manage CSR initiatives. These actions may come at a cost, and opponents point out that the money spent on CSR comes directly from shareholders' pockets. Former investment banker and current Tulane University professor Elaine Sternberg, one of the most vocal opponents of the effects of CSR on shareholder profits, points out that CSR initiatives incur great cost with little measurable return.[iv]
I don't make political or moral judgments about a company unless a client asks us to blacklist a particular company or industry due to one or more of their strongly held beliefs. For one, things are rarely black and white. For example, if the Gates Foundation gives to Planned Parenthood but Microsoft doesn't, does that mean we can invest in Microsoft or we can't? Secondly, the judgments on the gradation of a company's product or service are extremely complex - not to mention the time and cost of doing so. Is soda harmful? How about diet soda? If it is, to what extent and how much must be consumed for it to be harmful? Just as with personal politics, I advise you not to let a company's politics influence your investment choices.
Where Does It Stop?
I was illustrating this point to my son who had asked about coal. I showed him an economic map that revealed how the coal mines and rail lines intersect along the Appalachian Mountains. I then showed him the income statement of a railway company. He saw that coal represents a significant portion of their cargo and that the company lost billions of dollars over the last few years because of the decline in coal prices. Unfortunately, we can't light up a large city grid with renewable energy sources like solar energy yet. Thus, we still have to use gas and coal fired plants to power our nation - particularly since there remains a tremendous amount of fear regarding nuclear energy. Should an investor take a position that he won't invest in coal companies? Does that mean we also can't invest in the rail companies because they generate revenue from coal as well? Does that mean that we can't own utility companies because they're using coal to fire up their plants? If you have a prohibition against one particular issue, where does it stop?
The same holds true for environmental, social, and governance (ESG). Who determines what percentage of women on a company's board achieves adequate diversification? Who's to say that the things I believe in will be beneficial to society and therefore provide a better investment return?
Don't let yourself get sucked into thinking that social investing will deliver a better return. There are lots of companies selling grading classifications that somehow determine one company is green and worth investing in and another company isn't...or that this company has better social governance than this company. They love to cite individual situations to support their position, such as the reason why a particular board blew up is because it didn't take "proper human resources policies" into consideration. How do you get inside a company to make those determinations? If activist private equity firms and hedge funds with board seats have had limited to no influence on improving profitability, sometimes doing so by spearheading ESG efforts, how can an individual investor or institutional investment board of a foundation expect to do so?
To me, these issues are exceptionally subjective. Whether it's environmental, social, or governance scores, it's really the opinion of someone entering data into a computer and making subjective (and sometimes moral) judgments in hazy areas with limited internal knowledge of complex circumstances.
I'm completely agnostic toward ESG issues. I prefer to look at the numbers of the company and its potential. When meeting with company executives to determine qualitative data, I'm doing so to explore whether these are good businesspeople who are going to pay back the money we lend them. Good management is honest and understands that good governance naturally flows when ethical leadership and long-term profit seeking measures are aligned.
This is why I don't believe in activist investing and instead simply invest in good companies that I want to hold long term. Should I invest in a distressed issue, I am doing so because the price is cheap and I believe that the current or future management will eventually improve the sales and profitability of the company. Thus, I believe in ignoring ESG issues, investors are better served in making more prudent investment decisions and our firm will certainly continuing doing the same.
[ii] Jack Gray, "Misadventures of an Irresponsible Investor," Pension Management Fall 2012.
[iii] Larry Swedroe, "The Issues with Socially Responsible Investing," Moneywatch-cbsnews.com 20 Sep 2011.
[iv] Keith Evans, "What Are the Disadvantages of Corporate Social Responsibility?" bizfluent.com 26 Sep 2017.