As a fund manager, I believe it is my fiduciary duty to maximize returns for my investors, within the specific fund risk framework and regulatory regime.
Environmental, Social and Governance (ESG) investing involves excluding certain stocks from an investment universe based on a non-economic objection. But if you are so minded, it is possible to find a moral objection to the behaviour of almost every corporation.
It is also almost impossible to have an investor client base whose own views will agree with every non-pecuniary grievance held by their fund manager. Therefore, rather than impose a subjective view on our unitholders, I believe it is better to have none.
Instead, I remain focused on my fiduciary duty to maximize investment returns, leaving any philanthropy to the prerogative of the fund investors.
Excluding stocks based solely on non-economic factors can never result in higher returns because a smaller investment universe will always lead to fewer opportunities. It would involve an unjustifiable and arbitrary “tax” on my clients.
Indeed, this goes against an investment manager’s core fiduciary duty as the agent of the investors to act in their best economic interests.
The fund management industry is at its best when it offers consumers choice. I have no objection to funds at inception adopting the official EU compliance categories of “Article 8” or “Article 9” ESG piety, or whatever the future UK equivalence.
But there is no legal basis for an investment manager to prioritize moral or ethical considerations over financial performance on an ad hoc, subjective, and arbitrary basis.
Whereas ESG managers might argue that there are no compromises to investment performance from excluding non-ESG compliant companies, I have a different view.
I observe that the most highly rated ESG companies are often overly reliant on exogenous factors such as generous government subsidies or regulatory coercion of competitors, as well as historic zero interest rates and a general low cost of capital.
There is nothing “sustainable” about companies which cannot generate profits in a free-market economy.
Most investors would think that the inclusion of “governance” in an ESG investment process would involve an assessment on whether management are stealing from shareholders or cooking the books.
ESG “governance” focuses instead on adherence to a half-baked political agenda, such as reducing man-made carbon dioxide emissions, as almost the exclusive determinate of environmental virtue, or board and workforce representation based on ethnicity or gender, irrespective of their economic background or skillset.
It continues to expand relentlessly to any and every other trendy political issue of the day.
This is despite capitalism already being inherently meritocratic since its survival instincts require the best talent and optimal resources.
Rather embarrassingly, nearly every high-profile corporate blow-up in recent times has occurred with the rogue company having the highest ESG ratings. Like the gravy train TV evangelist, the most fervent ESG advocates often hide their base motivations under the cloak of morality.
ESG has spawned a bull market in mindless bureaucracy: how management ever get round to thinking about making a profit is not clear.
Many European companies are choosing to list in the US, where ESG reporting requirements are less onerous; smaller companies will not go public due to the extra compliance costs; whilst profitable old economy companies – shunned by public markets - will go private. We can have thriving European capital markets, or we can have ESG.
The creep of compulsory ESG regulation is deeply disturbing. All EU funds must now under “Article 6” regulation offer detailed explanations of the integration of “sustainability” risks into their investment process. In other words, the regulatory onus is already on funds with no ESG aspirations to explain why they do not conform to the official ESG liturgy. The direction of travel is ominously clear.
Democratically elected governments should be primarily responsible for law-making. It is therefore objectionable that what constitutes virtuous corporate behaviour is now decided by an unaccountable nomenklatura, who like a youthful cadre of Maoist Red Guards, exercise their ESG tyranny across corporations and financial institutions.
The logical endgame of compulsory ESG is that all public capital is allocated – not primarily for profit – but according to the political values of organisations which are not democratically accountable. This sounds a lot like the way communist economies work, with so far zero examples of economic success.
My definition of good corporate behaviour is that of economist Milton Friedman in that corporations have a fiduciary duty to maximize profit within the laws of society. As soon as corporate executives have a goal other than maximising profit, they lose accountability to shareholders, which is displaced by the need to manage different “stakeholder” interest groups.
Consequently, the boards of our listed companies end up being accountable to no one, able to indulge their own pet social and environmental projects, paid for with someone else’s money. CEOs become more interested in prestige and power than in profit. None of this is good for investors.
We have forgotten that profit has been the greatest motivation known to mankind to allocate finite resources productively; and that no society can have sustainable economic growth without profits and dividends that increase the capital base of the economy for future productive reinvestment. Additionally, without profit growth the private sector will crumble under the weight of tax burden in sustaining the ever-expanding public sector.
As soon as profit is displaced by non-pecuniary factors, capital gets repurposed for non-economic projects, which become a drag on productivity and economic growth. Whilst capitalism rightly creates “winners” and “losers” through efficient allocation of resources, the alternative created by ESG investing is a stagnant command economy where no one wins.
The fund management industry is currently sleepwalking into a dystopian ESG future. Far from “creating wealth and doing good”, ESG will destroy societies through an absence of economic growth that will inevitably come with the neglect of the profit motive. The consequences of ESG are profoundly immoral.
Always and everywhere compulsory ESG should be given the cold-shoulder by principled and profit - rather than politically - focused investors.
Barry Norris
Founder Argonaut Capital
March 2024
