Newton’s second law states that impact equals mass times speed. It is my conviction that sustainable investors have a greater impact than they often think. Not so much because of the speed, but because of the increasing mass. In the financial markets, it is the marginal buyer and the marginal seller who determine the new balance and it is here that sustainable investors give the right push.
Now, in the Netherlands this opinion is almost completely accepted, but in Anglo-Saxon countries it is seen as an extreme point of view. This is also shown by Robert Armstrong, a philosopher who, by the way, I highly appreciate, taught logic for five years at Columbia University and then worked at the hedge fund Seminole Capital Partners. For some time, he was responsible for the Lex Column in the Financial Times, where he still works. Armstrong does not believe in SRI and recently he saw this confirmed by Tarik Fancy, a former employee of BlackRock who wrote a long essay on the platform Medium.
ESG is intellectually bankrupt
Fancy was an ESG specialist at BlackRock, but can now be seen as a regretter. According to him, the ESG project is intellectually bankrupt and ESG does more harm than good. He even compares BlackRock’s position on Global Warming with the position of the National Rifle Association in relation to the many deaths each year in the United States from gun violence. Reading his essay, I cannot help but think that it says more about BlackRock than about ESG.
One of the arguments Armstrong and Fancy mention is that ESG investing causes the financing costs for bad companies to go up, while those for good companies go down. For a company, it is a cost of equity and debt, but for the investor it is a return. The conclusion is drawn that ESG investors must accept a lower return than other investors. The fallacy that is made is that we are looking at something static, whereas there is in fact enormous dynamism.
Private equity looks on greedily
It is true that sustainable companies are becoming more expensive and that non-sustainable companies are becoming cheaper. However, this does not mean a below-average, but rather an above-average return for sustainable investors. The best return can be achieved by a company that is seen as an unsustainable company that is transformed into a sustainable leader. Examples abound. This week it was announced that Esdec from Deventer wants to go public and is probably valued at no less than twenty times its turnover. The sustainable return here goes largely to private equity (Gilde) that bought this earthly business for a much lower valuation.
There are also companies like Alfen and Fastned on the Amsterdam stock exchange with sky-high valuations. You can bet that private equity is looking at these valuations with a greedy eye. Removing a company from the stock market and converting it into a comparable sustainable company can then easily be done. It also applies to larger companies. The valuation difference between the oil companies and the producers of alternative energy is extreme. You can bet that this is a strong incentive for the management and otherwise for the shareholders of the oil companies - even if they do not believe in ESG investing. Royal Oil, for example, is rapidly lowering its carbon footprint.
Fundamental bottom-up investors
Another argument by Armstrong and Fancy is that if it is indeed true that ESG ensures a higher return, it is not necessary to invest in ESG. In that case, all investors would already be working with ESG, so the extra return would have been arbitraged away. The mistake made here is to assume that markets are efficient. Now markets are much more efficient than one might expect, but people are certainly not.
Armstrong and Fancy are not alone; a whole army of Anglo-Saxon investors are just as sceptical. Experience shows, however, that the most fundamental bottom-up investors who are confronted with the ESG criteria all too often claim, on closer inspection, that they already apply these rules in their analysis. Investors who make such an extensive analysis of companies implicitly already look at ESG criteria. But that is just the tip of the iceberg. If the proportion of ESG investments is measured against, for example, index investments, it becomes clear that not everyone has been won over yet. There is still a long way to go.
Something to learn from: Sin Stocks
Other arguments of Armstrong and Fancy are that the horizon of the average crisis is not the same as the horizon of the average company. Investors’ horizons are often much shorter. However, a share is nothing more than a discounting of future cash flows. Certainly with the current low interest rate, a shift in those cash flows, for example as a result of ESG policy, can have a major impact on the current valuation. Such a shift can take place in the shortest possible horizon. But anyone who sells a share because of ESG criteria gives away part of the return to the buyer, according to Armstrong.
For a long time, this could be substantiated by the return of the so-called Sin Stocks, as would be seen in the VICE etf, but since its launch it has risen by 32 per cent compared with 70 per cent for the S&P 500 over the same period. Many of those Sin Stocks have lost their license-to-operate and then it becomes increasingly difficult to make money. According to Armstrong, by shifting from one investment to another, an individual investor has little influence and all those ESG rules actually make capitalism not work.
Not all factors that should be part of the cost price are included in the price of a product. ESG ensures that these external costs are internalised, it repairs the errors of capitalism. Green bonds cannot get Armstrong’s approval either, despite the fact that the demand for green bonds is so great that they outperform by an average of 0.3% a year.
Fortunately, Armstrong does come up with a sensible alternative for sustainable investment. According to him, a hefty carbon tax has much more positive impact than the pastime that is now called ESG investing. However, mainly companies with a relatively small carbon footprint will benefit from such a tax, and let those be part of sustainable portfolios.
Han Dieperink is an independent investor, consultant and knowledge expert for Fondsnieuws, Investment Officer Luxembourg’s sister publication. Earlier in his career, he was chief investment officer at Rabobank and Schretlen & Co. He is currently active as chief commercial officer at Auréus Asset Management. Dieperink provides his analysis and commentary on the economy and markets.