2024 Second Quarter

Can I summarize the results of a long-running debate about investing for good, in a few bite-sized takeaways?

Investment ESG (Environmental, Social and Governance) studies show certain quantitative anomalies.  However, many of these can be criticized for their cherry-picked data reflecting random biases that benefit from hindsight.  Manipulating a study to show a predetermined result isn’t proof of anything.  Here’s a summary of some findings that do shine through:

Investing for bad can be rewarding.  Theoretically, buying what others shun, it might make sense intuitively, should be profitable since the price of entry would be lower than it otherwise might be, and these types of badie companies often pay dividends accruing over time regardless of their poor corporate behavior.  For example, “badie” companies like alcohol, gambling, tobacco, weapons, and fossil fuel companies, each have their ups and downs.  However, unless a study’s start or end points are set at their highs or lows, respectively, the total returns of badie stocks are in fact pretty good.

As far as the G in ESG, a company’s governance, significant profits can be gained by investing in companies for policies and practices promoting board independence, oversight, diversity and accountability over management.  Many technology companies have poor executive compensation or weak shareholder rights, yet they are frequently included in ESG funds and have been quite profitable despite poor G marks.
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Moving on to the S, social, employees are motivated by more than pay and benefits.  Happy, educated, diverse and motivated employees, given the opportunity, do better work.  This can be surveyed directly or scraped from social media sites like LinkedIn or Glassdoor.  We utilize such data for individual stock picking or purchase it in the form of the Human Capital funds.

Human capital is not accounted for on financial balance sheets and can otherwise be difficult for investors to measure.  Studies show higher investment returns associated with superior human capital, as much as 4% higher returns annually according to one study of historical data.

Finally, an analysis of the E factor is great at identifying future environmental risks but has actually been shown to have been a bad predictor of enhanced stock market returns.  This makes sense, as a company dumping into the environment spends natural capital whose toll will be paid by the ecosystem, to the detriment of future human generations and life on Earth, rather than by shareholders and the companies themselves.  Poisoning the environment can be profitable, unless corporations are held to account for their misdeeds, so the hope is that reporting their environmental records and management policies publicly might in the future hold them accountable,  Still, regulators must do their jobs because the investment markets reward shareholders for their companies’ future profitability, not for their pollution control or renewable energy investments (as evidenced by very poor stock market returns of most solar cell manufacturers).

One example, while not a corporation, is the recent case of a Maine seacoast homeowner who poisoned her neighbor’s trees with the herbicide Tebuthiuron to open up her ocean views.  The neighbor had their soil tested.  This led to $1.7 million in fines and settlements for killing the trees and leaching poison into adjacent parkland and waters.  If the perpetrator were judged in high regard only for her service as head of the half billion dollar St. Louis Community Foundation charitable endowment, which I suppose would be the S or social contribution if we’re looking at it from an ESG perspective, then she might be rated well ESG-wise, even though obviously environmentally atrocious.  If nobody paid attention, she would have gotten away with it.

Pay attention.  If we don’t like what we see, we stay away, period.  As the saying goes, there are plenty more fish in the sea.