ESG developments this week

On Wall Street and in the private sector

An Oracle’s opposition

The big story in the ESG world last week was the news that the so-called Oracle of Omaha, Berkshire Hathaway CEO Warren Buffett, opposed ESG proposals on his company’s proxy statement and was able to rally support among members of the board of directors and other shareholders to defeat proposals that would have forced the investment company to disclose various ESG data for all of the companies it owns. Buffett argued, and a majority of shareholders agreed, that the costs associated with such an effort would be damaging to shareholder value and, in his view, provide little by way of useful information. Reuters put it this way:

“Buffett and his board opposed two shareholder resolutions at Berkshire Hathaway’s annual shareholder meeting last week that called for annual reports on how its companies are responding to the challenge of climate change, as well as reports on diversity and inclusion in the workplace.

He prevailed, supported by directors who along with him control a combined 35% of Berkshire Hathaway’s voting power. But some of his top investors, including BlackRock Inc (BLK.N), the world’s biggest asset manager, were part of the roughly 25% of Berkshire Hathaway shareholders who defied him and voted for each resolution. The California Public Employees’ Retirement System, the largest U.S. public pension fund, and Federated Hermes Inc (FHI.N), the $625 billion asset manager based in Pittsburgh, were among sponsors of the climate-change resolution.”

While, according to the report, many shareholders appear to be drawing the line on ESG, even without Buffett and the board’s 35%, the resolution did not muster the support of a majority of outstanding shares, losing 40%-25%. 

ESG pioneer reexamining fiduciary duty

In her BloombergOpinion column last week, Shuli Ren disclosed that the world’s largest pension fund—Japan’s $1.6 trillion Government Pension Investment Fund—has begun questioning its involvement in ESG, with some employees reexamining their fiduciary responsibilities as they relate to socially responsible investing. This reexamination, in turn, has led the fund to cool its support for ESG:

“In July 2017, Japan’s $1.6 trillion Government Pension Investment Fund — the world’s largest — blazed a trail by putting 1 trillion yen ($9.1 billion) into three indices that track Japanese stocks that put emphasis on environmental, social and corporate governance issues. GPIF then plowed 1.2 trillion yen into two carbon-efficient indices in 2018, and another 1.3 trillion yen into two ESG foreign equity indices last December.

But top officials of the pension fund have been talking up fiduciary duty lately. GPIF “can’t sacrifice returns for the sake of buying environmental names or ESG names,” a senior director at the fund’s investment strategy department told Bloomberg News in April. 

At issue is poor performance. For instance, one of GPIF’s earliest ESG picks was a thematic social index, which invests in domestic companies that hire and promote women. The MSCI Japan Empowering Women Index, the so-called Win index, has fared poorly against the benchmark Topix Index. Performance is all-important to GPIF: the fund is required to pursue a real investment return of 1.7% to support an aging Japan.

Over the last year, the Japan ESG indices that GPIF tracked could not outperform the benchmark Topix Index. 

Ren concludes, starkly:

No doubt, with the European Union and Biden administration pushing fiscal stimulus money into clean energy and climate technology, ESG investing will remain a hot topic. But if the world’s largest pension fund seems to have become more circumspect, shouldn’t you? From the perspective of pure returns, passive ESG investing can still be fruitful, but one has to be nimble and practical, able to switch quickly from one thematic fund to another — or out of ESG funds altogether. Dogma won’t work.”

BlackRock identifies ESG as the future of global investing

This past weekend, CNBC recapped an interview with Armando Sebra, the head of BlackRock’s iShares Americas, who insisted that ESG is the wave of the future for global investing. “We are just at the beginning” of the ESG era, Sebra said in a brief interview with the network’s Bob Pisani. CNBC continued:

“Environmental, social and governance (ESG) investments could become a $1 trillion category by 2030, BlackRock’s head of iShares Americas, Armando Senra, told CNBC’s “ETF Edge” this week.

With U.S. investment in iShares’ suite of ESG funds starting to pick up in earnest this year, “we’re just at the very beginning” of what could be a decade-long growth story, Senra said.

ESG funds are on track for a record year of inflows, raking in over $21 billion in the first quarter of 2021. That’s an acceleration from 2020, when they earned over $51 billion for the year; 2019, when they accrued $21.4 billion; and 2018, when they saw about $5.4 billion in inflows.

Senra attributed the interest to larger asset managers and model portfolio managers incorporating sustainable investments into their strategies in more impactful ways.”

Study on ESG alpha goes public

In the last issue of this newsletter, we noted a study, conducted by the company Scientific Beta, that purported to show that the alpha—i.e. the excess return over the market average—generated by ESG funds is a myth created by mistaken categorization of risk. The article we cited, published by Institutional Investor magazine, claimed to have seen the study, even though it had not yet been published. This week, the study and its results became public and have circulated among the niche and mainstream financial press. Among others, The Financial Times noted the following:

““There is no ESG alpha,” said Felix Goltz, research director at Scientific Beta and co-author of the as yet unpublished paper, “Honey, I Shrunk the ESG Alpha”.

“The claims of positive alpha in popular industry publications are not valid because the analysis underlying these claims is flawed,” with analytical errors “enabling the documenting of outperformance where in reality there is none”, he added.

Scientific Beta analysed 24 ESG strategies that have been shown to outperform in other academic papers. It did find evidence that ESG funds have tended to outperform, with ESG leaders typically beating ESG laggards by almost 3 percentage points a year.

However, in both the US and other developed markets, it found that three-quarters of the outperformance is due to “quality” metrics, such as high profitability and conservative investment.

Quality has long been recognised as one of the investment “factors” that have traditionally tended to drive above-market returns.

“Despite relying on analysis of non-financial information by hundreds of ESG analysts, ESG strategies perform like simple quality strategies mechanically constructed from accounting ratios,” the paper said.

“Of the 24 strategies, not one has significantly outperformed when you adjust for this factor and that to me is quite striking,” said Goltz. “It’s just the case that over the last decade quality has outperformed and if you use ESG scores that inherently tilts [a portfolio] to quality.

“You can ask the question; what is the value of the ESG analysis?” Goltz added, if ESG portfolios can be constructed simply by analysing high-level balance sheet data.”   

Former Managing Director at AQR Capital argues ESG funds cost more

In his May 7 BloombergOpinion column, Aaron Brown argued that there is very little difference between most ESG ETFs and an S&P 500 fund—with one exception, the ESG fund costs more for investors:

“Want to align the core of your investment strategy with climate-change values? Or build a sustainable equity portfolio for the long-term by focusing on environmental, social and governance goals? A variety of ESG exchange-traded funds have made these and other promises. But as the table below shows, they mostly hold the same large capitalization technology stocks as the S&P 500 Index, represented in the top row by a popular ETF with a miniscule 0.03% expense ratio, in similar weights.

Not only are the portfolios similar, but performance is nearly identical. The Vanguard ESG fund has a 0.9974 correlation to the S&P 500 fund since inception in September 2018, which is higher than most index funds have to their benchmarks. A correlation of 1 would mean the two funds run perfectly in sync.

Instead of putting $10,000 in the Vanguard fund, you could put $9,948 in the S&P 500 fund, and $52 in a long/short fund that bought a bit more of some stocks and shorted small amounts of others so the combination of the two funds had precisely the same holdings as the Vanguard ESG fund. The ESG fund charges $12 per year in expenses, while the index fund charges $3. The extra $9 in fees is really paying for the $52 “active share” fund, an annual expense ratio of over 17%!

The other ESG funds charge similar outrageous fees for tiny adjustments to the S&P 500. FlexShares charges 0.32%, which works out to 16% on the active portion of its portfolio. Conscious Companies charges 0.43%, but has a lower S&P 500 correlation, so is a relative bargain at only 11% for its active portion. SPDR charges 0.20%, or 18% on the active portion. ESG Aware is the second cheapest on raw fees at 0.15%, but its sky-high correlation of performance with the S&P 500 means you’re paying more than 20% on the active share.”

In the spotlight

Business schools jump on the bandwagon

According to The Financial Times, large businesses and some business schools have begun working hand-in-hand to educate corporate employees about sustainability efforts and their importance and to turn ESG into a much more mainstream business practice and investment strategy. Focusing on Nespresso and NYU’s Stern School of Business, the paper reports the following:

“By taking a commodity and turning it into a luxury product, Nespresso has generated billions in sales from its coffee pods. Boosted by the endorsement in its adverts of actor George Clooney, the company, owned by Swiss multinational Nestlé, has an annual turnover of SFr5.9bn ($6.3bn).

However, Nespresso has come under heavy criticism over the environmental impact of the aluminium pods that end up in landfill, because the metal is not biodegradable. It can be recycled, though.

Nespresso turned to NYU Stern School of Business in New York to create a custom executive course, run most years since 2016, to help employees understand coffee sustainability. There have been 118 participants, from different levels of the company, and what they have learnt has already helped it improve recycling rates.

Attendees visit a coffee farm in Costa Rica to understand the company’s sustainable sourcing programme, set up in 2003 with the Rainforest Alliance, an environmental organisation. They also take business classes, learning about brand storytelling to court consumers, and are encouraged to develop proposals for projects on the course — for example, ways to reduce waste in Nespresso’s offices….

In the wake of the 2008 financial crisis, some critics labelled business schools “academies of the apocalypse”, arguing that they were partly culpable. Many institutions, however, are moving beyond the shareholder-primacy model and emphasising the longer-term interests of employees and broader society in their executive education programmes, encouraging organisations to become better corporate citizens.

This month, the University of California Berkeley’s Haas School of Business launches a new course on how to integrate sustainability into a business strategy. Robert Strand, executive director of Haas’s Center for Responsible Business, says the pandemic has put “stakeholder capitalism on steroids”. It has “exposed and worsened inequalities, but it’s also an opportunity to change the narrative of capitalism, and redefine the purpose of a corporation”, he adds.

Academics disagree over whether coronavirus will really reset capitalism, but the appetite is strong for executive courses that go beyond the bottom line. Nicholas Pearce, professor of management and organisations at Northwestern University’s Kellogg School of Management in Illinois, says many executives are interested in using business as a platform for social change. “The pandemic forced people to reflect on their responsibility to use positions of privilege and power to do good,” he says.

Pearce says Kellogg’s corporate clients are increasingly requesting bespoke programmes on social purpose, employee wellbeing, and diversity and inclusion. Likewise, Ioannis Ioannou, associate professor of strategy and entrepreneurship at London Business School, agrees that demand for such training outstrips supply. “Coronavirus has awakened the ‘S’ in ‘ESG’,” he says, reflecting a rethink by companies particularly on social issues alongside environmental and governance factors.”

Notable quotes

On the perceived potential for an ESG/Bitcoin collision

“To the extent that financial firms need to improve on the sustainability of cryptocurrency products, this can be achieved for example by purchasing carbon credits at the custodial level to offset the current carbon impact of mining per coin held in custody per unit time.

So far, we have seen limited specific demand for such offsets and to my knowledge no large custodians currently offer them but it may well become a common product component.” 

Chris Bendiksen, head of research at CoinShares, “Bitcoin Under ESG Scrutiny,” etf.com, May 5, 2021.