“There is one and only one social responsibility for companies – to use their resources and engage in activities designed to increase their profits.” This view of the Nobel Prize winner Milton Friedman in the 1970s is now considered outdated. The trend has been going in a different direction for a long time.
Companies should manage themselves according to ethical principles and, in addition to maximizing returns for the owners, also pursue other goals, such as protecting the climate and the environment and a more just society. This is summarized with the abbreviation “ESG” – environment (environment), social (social) and good corporate governance (governance).
Companies choose their employees accordingly, savers and large investors demand a corresponding orientation. Asset managers promise to pay attention to this when investing. In studies such as the Axa Investment Manager for 2021, they show that ESG-oriented investments are not only good for the conscience, but also for the wallet. No wonder a lot of money has flowed into ESG funds in recent years.
However, the investments with the ESG label are not quite as undisputed as it appears. It has long been known that companies are classified differently by different rating agencies and that the criteria are weighted differently in the evaluation. For example, an oil multinational like Total Energies can be ESG compliant if it underperforms the industry average. It is also known that some facilities are designated as “green” when they are not.
In the USA, ESG has now become the focus of political debate. While Democrats are in favor of investing according to ESG criteria, Republicans are calling for pension funds to withdraw money from ESG funds. Representatives from 19 Republican-governed states have written to Blackrock boss Larry Fink about possible violations of the law. The aim of the investment is to generate the highest possible return for the investor, not to promote other goals. US President Joe Biden had to veto an anti-ESG law on March 20.
Daniel Stelter is the founder of the discussion forum “beyond the obvious”, which specializes in strategy and macroeconomics, as well as a management consultant and author. Every Sunday his podcast goes online at www.think-bto.com.
(Photo: Robert Recker/ Berlin)
Many advocates do not see a conflict of goals
For many proponents of ESG investing, the trade-off between returns and ESG does not exist. On the contrary, observing ESG criteria would only ensure that shareholders continue to earn good money in the future.
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The demise of Credit Suisse due to glaring failings in corporate governance underscores this. However, it is symptomatic of the weaknesses of the ESG ratings that the bank had good to medium ESG ratings. So it’s worth taking a closer look.
How money managers invest their own money is a surefire indicator of how serious they are about what they say. If an asset manager invests a lot of his own money with investors’ money, it can be assumed that he is investing in a way that optimizes risk and return from his point of view.
Vitaly Orlov from the University of St. Gallen and two colleagues have shown in a study that the investment behavior of fund managers who also manage their own money differs in terms of ESG from that of pure management of client funds.
The economists analyzed 1216 actively managed, diversified US equity funds designated as ESG funds from January 2015 to December 2020. The result: As soon as the manager has his own money in the fund, the investment strategy deviates from the strategy actually specified according to ESG. The more money the manager has in the fund, the greater the deviation. If he withdraws his own money, the fund becomes ESG-compliant again.
Money managers do not believe in the superiority of ESG-compliant investments
This clearly shows that money managers – at least in the USA examined here – do not believe in the superiority of ESG-compliant investments. ESG as a label is primarily used to attract investment funds. If you also look at the returns of various investments in 2022, you can’t help but notice that those who were not bound by the principles of ESG had a better chance of returning.
Hardly anyone wishes to return to the ideas of Milton Friedman. Nevertheless, we should seriously ask ourselves whether ESG, as it is practiced today, with promises that are not meant to be taken seriously and questionable criteria, might not do more harm than good to investors and society.
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Daniel Stelter is the founder of the discussion forum beyond the obvious, which specializes in strategy and macroeconomics, as well as a management consultant and author. Every Sunday his podcast goes online at www.think-bto.com.