How to think about ESG investing in a falling market
Every time the stock market drops, investors are likely to rethink almost everything.
The current gut check comes at a time in the evolution of the investment industry where assets of so-called ESG funds have grown 38% over the past year, to $2.7 trillion at the end of March, according to Morningstar Direct. Professionals overlay all sorts of rules and filters for the investments they choose, using climate, diversity or other data to build what now has more than 6,000 funds worldwide.
There is a cost for the conscience: the funds have often high fees this can reduce returns if investments do not perform better than all the alternatives you reject. And there is some confusion about the practical meaning of the term ESG – short for environmental, social and governance.
This can lead to episodes like last month when Elon Musk called the entire industry a “scam” after S&P Global had the audacity to remove Tesla from an ESG index. S&P did this, It saidpartly because of accusations of racial discrimination and other mistreatment of workers.
Meanwhile, the Securities and Exchange Commission is frantically try to catch upinvestigating Goldman Sachs and other big banks and wondering if any are affixing ESG labels to funds that may not be worth grabbing investors’ assets.
To try to help ordinary investors understand this, I turned to two professionals who have spent quite a bit of time vetting budding ESG investing.
The first is Amy Domini72 years old, founder and president of Domini Impact Investments and a pioneer in the ESG field. The second is Rachel Robasciotti43 years old, founder and managing director of Adasina Share Capitalwhich describes itself as an “investment and financial activism” firm.
Here’s what they had to say.
RON LIEBER: What is the most precise definition of ESG today, and how has it changed?
Amy Domini: Before we begin, is this the preferred vocabulary? When I started it was “ethical investing”, but I lost so many vocabulary battles in my life.
I view it as providing a more robust set of material data points from which an investment advisor can make a decision.
And I see that as fulfilling a fiduciary duty. Assets are not managed in the best interest of the beneficiaries if, in effect, they cannot breathe or life is too dangerous at the end of their wealth building. So I see it as a means to an end, and that end is a livable planet – and lives worth living. And I see it as a strategy that explicitly recognizes that investors have a role to play in delivering these results to the world.
The state of the stock market
The decline in the stock market this year has been painful. And it remains difficult to predict what awaits us for the future.
LIEBER: Rachel, you knew about Amy’s funds. Did you come to a different conclusion?
RACHEL ROBASCIOTTI: We call our work “investing in social justice”. It is the deep integration of four areas: racial, gender, economic and climate justice.
LIEBER: Defining justice seems messy these days. On the one hand, some investors do not want to invest in arms manufacturers. On the other hand, many of them would very much like to put more weapons in the hands of the Ukrainians.
ROBASCIOTTI: In the world our investors want to live in, the government is responsible for weapons and defense, and it’s not a private business.
LIEBER: Wait, so the government should produce weapons?
DOMIN: Capitalism is excellent at distributing goods and services on a large scale and at a lower cost. Weapons should not be distributed on a large scale and cheaply.
LIEBER: Academics have been talking for years that so-called active investing is a bad idea — that it’s just too hard to actively pick stocks that will do better than others over the long term. Doesn’t ESG investing violate these principles?
ROBASCIOTTI: In order to do a good job of investing in social justice, you need to be active on these issues and be alert when a company’s behavior changes in ways that have a real and material impact on its future.
DOMIN: Take the place. They had an arguably strong history of empowering small business owners, a strong economic justice theme that could get you excited. As they became more and more of a blockchain company – to the point where they changed their name, that initial exciting thesis became less and less present.
LIEBER: Perhaps it is best for curious investors to play with the word “active” and think of ESG as an activist investment. If someone has to pay the higher than average fees – or at least the higher fees than the basic index funds that companies like yours charge – it shouldn’t just be a matter of moving money into silence from one public company to another in a way that may not have much impact. Activists are pushing. They are making noise.
DOMIN: We wrote to 150 companies in Japan, pointing out that there were two genders and that their boards did not reflect that fact. Japan doesn’t have strong shareholder resolution opportunities, but that doesn’t mean you can’t have a bit of activism.
LIEBER: We are currently in a bear market. This is often a time when people are looking to cut costs in their investment portfolios. The investment industry has long complained that your funds are not cheap. Do you lose in these kind of market conditions?
ROBASCIOTTI: Historically, women, people of color — especially black people like me — weren’t allowed into the industry. And now that we’re starting to emerge, we’re in a situation where we have this huge price pressure. “Reduce your costs!
Organizing, mobilizing, educating other investors, gathering data sets – it all takes people. You have to be able to invest in it.
So I really wonder if anyone is delivering impact at a very low price. Very, very, very often with a cheap ESG you could hit a wall of data and stop. And what we’ve done is break through the data wall.
LIEBER: Okay, but do you still trust the data you get from the companies themselves – the raw numbers or how they can selectively count things?
ROBASCIOTTI: We use less data that companies provide themselves. Data collected independently by third parties who verify it with public company practices is what we really rely on.
LIEBER: Elon Musk would disagree on the added value of ESG. How would you try to persuade him in 100 words or less?
ROBASCIOTTI (laughing) Here’s what I’d say: The reason you’re confused is because you’re a one-issue CEO, and that’s not the way of the future. The way of the future is people and planet, and a fractured society can’t do anything, including electric cars.
DOMIN: He went after my industry instead of going after the index that excluded him. Not the whole industry kicked him out.
LIEBER: Individual investors face dozens of ESG choices. Goldman Sachs and others hope household names will count. What is the right framing question that individuals should ask when purchasing funds?
ROBASCIOTTI: There are actually three. The first is, what are your problems? For us, these are race, gender, economics and climate, because these are the places where capitalism extracts value unsustainably.
So how do you measure it? And the most important question, without a shadow of a doubt, is who decides what matters? Go to the people most affected and ask them what matters, because they are closest to the problem and often furthest from power. And that’s information that investors don’t get right now.
LIEBER: What is the most non-obvious example of this third?
We have created a set “Investors for Living Wages” campaign and had a collective investor statement that was more than half a trillion dollars in investor money, via signatories advocating for all public companies to end sub-minimum wages.
LIEBER: This all sounds like a lot of work for the investor. Where is my interactive tool that allows only one of many funds to fall as my top pick?
DOMIN: I think a step is better than no step. I’m not totally hooked on who does a better analysis, or an analysis that is consistent with my own analysis. I’ve looked at so-called strict portfolios that contain stocks that I wouldn’t put in my portfolio.
LIEBER: So this analysis paralysis is my problem — it’s not the industry’s problem?
DOMIN: I love women owned businesses, if you want to start with something!
ROBASCIOTTI: Just 1.4% of all U.S.-based business assets are managed by businesses owned by women or people of color. So you can restrict your universe here.
The reason it’s important is that doing it like we always have has given us the world we have now. If we’re going to have a different world – if we’re going to invest in doing more of what we actually want – we’re going to have to choose a different set of people who haven’t been to the table yet.