If you are following the news about ESG these days, there is no shortage of controversy about the subject. As money managers, we follow the numbers and like most things that become popularized and politicalized, there are good and bad aspects of any idea that achieves full-scale adoption. According to a recent editorial by the Wall Street Journal, “the tide has turned on environmental, social, and governance (ESG) investing”. In fact, the investment arms of many large institutions, like JPMorgan Chase, Pimco, and State Street, recently left Climate Action 100+; and others, like BlackRock, shrunk their involvement in the group. The Right is accused of “weaponizing” ESG as “woke capitalism”, while the left seeks to call out institutions that are not “fully committed to the cause”. Here’s our perspective on the subject–taken directly from our Statement on ESG Principles.

What really is an ESG strategy?

Environmental Social Governance (ESG) strategies can be defined and implemented in so many ways that even regulatory agencies are showing increasing concern about the lack of consistency and general confusion that ESG is creating for investors. Do regulators really want strategies being sold to consumers where alternative objectives (other than financial gain) are touted, but can’t really be measured? Especially, when there is contradictory evidence — at best — that these strategies add value?

Generally, given the shortcomings briefly described above, we are skeptical of ESG principles as tools to identify attractive individual stock opportunities, in and of themselves. However, some of these ideas have merit in conjunction with a time-tested fundamental investment process.

What’s key is to consider how well a company is comprehensively managed, both in an absolute sense, and with respect to current and future expectations. We included some of these concepts in our validation process – without calling them “ESG”–even including some of these concepts as certain factors demonstrate their efficacy.

  • Environmental impact is tricky — Regardless of sentiment, direct and indirect impacts, costs, and benefits must be honestly evaluated. Are Electric vehicles a “net positive” to society? While the upfront costs are higher, the operating costs are lower over time. However, the magnitude and timing of these considerations depend on characteristics like geography, access to resources and technological advancement across markets. Upon further consideration, the answer is unclear.
  • Governance matters — But quotas or token membership can have a limiting effect. Board diversity in general seems like an easy decision and there is evidence already that it leads to better-managed companies. However, packing boards with serial celebrity members without experience relevant to the specific business seems gratuitous and irrelevant to future success. The devil is often in the details.
  • Social issues are a minefield — And, in the eye of the beholder. Do the benefits of tools that make businesses more productive, effective, and efficient in reaching its customers outweigh the harm to our mental and emotional health and personal relationships, especially for our youth? How is the cost to society measured for these purposes? Difficult issues that require careful consideration.

How these ESG concepts interact, and which take precedence, also requires judgment and experience. For instance, if a company scores high on protecting its customers privacy (“Social”), but manufacturing its products indirectly harms the climate (“Environmental”), do these serve as an offset? Is it enough for a company to have an ESG-friendly plan and be “improving” in these categories, or is a certain level of minimum competency required?

For ESG and any other important idea, we favor a wholistic approach, because: Truly meaningful points of inflection are not found by following a single idea; there is no need to tout certain characteristics with any monicker-even when it may be otherwise advantageous to do so; the path to better outcomes is not a straight line. And, in good time, hard work and long-term performance always speaks for itself.

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Validus Growth Investors, LLC seeks to invest in companies at every stage of their growth. From startups to publicly traded companies, our research identifies inflection points that have the potential to produce meaningful growth and income for the clients we serve.

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