Toward a New ESG

Toward a New ESG

The modern financial ESG movement is changing the face of investment in the United States. The vague acronym stands for “Environmental, Social, and Corporate Governance”, and is said to specify the factors that socially-conscious investors use to make investment decisions. Conservatives have tended to either tacitly accept ESG investing under the presupposition that it benefits the common good, or oppose it due to their Miltonian dispositions toward shareholder returns. Both approaches are inadequate. Conservatives wielding capital ought to consider building a distinctly alternative ESG, optimizing the best themes out of available ESG investment products while substituting in their own flavor of values-aligned investing. Rather than condemning or copying mainline ESG investors, they should rigorously form new investment theses and financial products that align with specific moral visions advancing the common good.

While there are components of the present-day ESG movement that ought to be commended, many raise concern. First, the largest institutional investors in the U.S. consistently spout the narrative that ESG investing makes investors more money by reducing environmental, human capital, and governance risks. Unfortunately, this widely-accepted view is uncorroborated in serious academic literature. It seems ESG strategies underperform relevant benchmark indices and mutual funds.

Also, few agree on what a proper ESG investment is once you state the obvious. Hundreds of organizations like Thomson Reuters and Bloomberg provide ESG ratings of companies based on their own evaluation and methods to help investors identify the most “socially and environmentally responsible” firms. But studies find that the different ESG rating platforms have awful convergence. Without any robust understanding of ESG definitionally, institutional investors become moving targets. They can shirk their fiduciary responsibility to compound returns and simply explain away poor performance in terms of ambiguous and shifting social agendas. Teachers, policemen, and public servants are cheated out of the full reward of their pension because some ESG investors decided to be “socially and environmentally conscious” on their own terms instead of buying the S&P.

Third, ESG investing has become the continuation of politics by other means. To the detriment of conservatives, many ESG funds unabashedly employ politically progressive investment criteria. Ninety-five percent of all shareholder proposals that focus on environmental, social, or governance issues are submitted by liberal interest groups. In 2020, liberal leaning investors and environmentalists scored a record number of wins at US companies whose shareholders approved their proposals. Barring a few proposals calling for attention to ideological diversity, no meaningful proposals have been even submitted by America’s other side.

Greater concern for fair treatment of workers, sustainable business practices, and healthy governance is good and right, but many ESG investors seem inclined to push these directives past reasonable justification. Their fast and loose treatment of fiduciary duty and unbridled social and political activism will damage American interests. Corporations, though often depicted as villains requiring reform, are the engines which drive American innovation, competition, and economic opportunity. Divorcing companies from their proven business models, distracting them from key objectives, and luring them to compete on signaling progressive virtue rather than building better products and services will subtly yet undoubtedly damage American competitive primacy.

For example, Germany’s stakeholder-centric mandate of labor board representation, has been associated with significant discounts applied to corporate valuations and Volkswagen’s repeated scandals in 2005 and 2015 due to increased conflicts of interest. Similarly in Japan, far-reaching stakeholderism led to corporate conditions of entrenchment and moral hazard across Japanese firms resulting in the 1990s “lost decade” recession. Japanese firms today continue to struggle with poor returns on equity, lack of corporate innovation, and discounted valuations.

Many conservatives’ reaction has been to reject the entire concept of ESG, but this is  not a practical strategy. Net flows into sustainable funds more than doubled from 2019 to 2020, and sustainable investing now accounts for one-third of total U.S. assets under management. Mutual funds have found that their categorization as a high-sustainability fund is correlated with net inflows of capital. In short, ESG investors are becoming extraordinarily popular. So rather than hopelessly condemning ESG financial products and ceding ground in capital markets, conservatives ought to moderate the excesses of current ESG investing by creating their own.

However, copying liberal interest groups and submitting shareholder proposals to “make corporations more conservative” without significant capital seems like a losing strategy. To gain traction, a careful crafting of financial products with specific theses that are uniquely compelling in both risk-return profile and broader mission is required.

For example, Eventide, a faith-based asset manager with ~$8 billion AUM, has crafted an array of investment products including a Healthcare and Life Sciences Fund and Exponential Tech Fund “representing its ‘best ideas’ for long-term capital appreciation whilst creating value for society and the global common good.” Some funds, particularly in private markets, may find success in crafting theses around underrepresented geographic regions, national security, or corporate culture. As in Japan, activist hedge funds in the U.S. may soon find investment opportunities to engage bloated firms and pressure them to recant on extreme stakeholderism and moderate their ESG policies.

ESG is going nowhere, and is backed by massive inflows of capital and a liberal managerial elite.  Despite several commendable attributes, many of these investment policies lack rigor, incentivize poor fiduciary accountability, and are unreasonably pressuring corporations towards progressivism. To effectively provide an alternative and serve as a moderating force on today’s ESG movement, it is time conservatives build their own.

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