Is ESG a new standard for conducting business or just the latest marketing ploy?
Milton Friedman must be rolling over in his grave.
A few weeks ago, KKR closed its first ESG fund at a whopping $1.3 billion USD. For a behemoth asset manager, they are late to the game. According to Morningstar, investors put $20.6 billion USD into ESG funds in 2019, which is 4X the amount in 2018. ESG funds now account for more than $30 trillion USD AUM globally and BofA estimates that there will be over $20 trillion USD of growth in ESG funds over the next 20 years.
So, what exactly is an ESG fund? ESG stands for the words “Environmental, Social, Governance”, respectively. Managers of ESG funds look for assets that demonstrate sustainability in the three categories. In the age of “cancel culture”, businesses are more closely attuned than ever to the power of public perception and the impact it has on their livelihoods. One glaring example is Victoria’s Secret, a global leading women’s lingerie brand, which was worth $29 billion USD less than 5 years ago. Fast forward to a couple weeks ago, the embattled company was taken private at just over $1.1 billion in valuation after a series of governance mishaps: first, after missing the growing trend of body-positivity, long-time Chief Marketing Officer Ed Razek made controversial comments regarding plus-size and transsexual women. Not long after, CEO Lex Wexner was linked to the Jeffrey Epstein scandal.
Customers today, whether retail or enterprise, want sustainability not only in the products they buy, but also in their investments. That’s where ESG funds come in. ESG funds try to only invest in companies who take responsibility in their environmental impact, social activism, or respectful governance. It is basically the exact opposite of the Friedman Doctrine, which is a normative economic theory that a company’s only responsibility is to its shareholders. Milton Friedman argues that shareholders can take social responsibility on their own, so the person they appointed to maximize shareholder value should do just that. This model became prominent in the 1980s, with GE’s Jack Welch, who passed away this week, as its fervent disciple. Such school of thought spawned a generation of active investors like Carl Icahn.
Times have changed, however. In August 2019, the Business Roundtable, a non-profit whose members are the top CEOS in the U.S., made a loud announcement that they will no longer put shareholders first. Prominent CEOs such as Tim Cook and Jeff Bezos have agreed to advancing “conscious capitalism”, where shareholder profit should not come at the expense of positive social and environmental impact. (Sorry Milton!)
This monumental shift in company management’s priority did not come skepticism-free. Many people questioned whether the CEOs would follow through or are they just looking to generate positive PR? Others, pointed fingers at how sustainable can these companies realistically be? Take Tesla, a leader in emission-free electric vehicles, who last week, in German court, won the right to plow down a forest near Berlin, in order to build a new plant. Another example is Tim Cook’s Apple devices, which contain many elements such as lithium, the mining practice for which can be detrimental to the environment. How about the carbon footprint from Amazon’s marquee offer: the 2-day-shipping supply chain? The list goes on.
At Wealhouse, we perform great diligence and detailed end-to-end research before we label a company “sustainable”. We also interview and dialogue with management teams on a regular basis. We will always ask for proof of how a management team is trying to improve their ESG impact. Unlike Milton Friedman, not only do we believe that ESG is great for business, but based on the stats above, it can be a great way for companies to tap into the massive pools of capital. The jury is still out on a regulated standard of how sustainable a company should be before it can be considered “ESG”. However, we are happy to see, for the sake of our world, more and more investors putting social responsibility on the same or higher importance level as shareholders’ profit.