Environmental, Social and Governance (ESG) investing – watch out for zealotry

ESG. I’m glad someone came up with another acronym, because I find that in the field of investment, you can never have too many acronyms. This one clumps together the concept of including factors relating to the environment, society and governance into investment decisions. Sounds fair. The problem is that the ESG acronym is a magnet for zealotry.

On 3rd October 2014, the Australian National University announced that it would divest its holdings in 7 mining and resource stocks in its Australian equity portfolio. The reason given was that the University had reviewed its whole portfolio with reference to its Socially Responsible Investment Policy and this group of 7 were to be cut out as a result. Presumably , the blacklisted group did not meet the standards required by the ANU in its policy. This announcement has caused a stir in Australian investment and political circles. The ANU has been criticised, as has its advisor, by commentators, political figures and some of the 7 companies themselves. There is at least one court action underway and there could be further lessons to come out of the process when it is finally over.

In the meantime, if any person investing under a fiduciary duty (eg a superannuation trustee) or as an agent of a principal (eg company executives investing company money) uses ESG principles as a filter to determine the investment universe, in my view they are in breach of their duties. If ESG is elevated to the first criterion and a possible investment is excluded on those grounds alone, regardless of its other prospects, that is a breach of duties. Normally, a decision to invest (or divest) is made after reviewing many factors and ranking alternative investments to get the best possible mix. Factors that we now refer to as ESG factors are almost always included in that assessment, provided they are sufficiently material.  But ESG has the potential to attract zealots who, by virtue of their own personal beliefs, want to exclude certain investments altogether. Specifically, fossil fuels, mining, tobacco and gambling stocks are at risk. ESG advocates want to raise all ESG factors to be the first criterion and only if the company passes those tests does it remain to be assessed against other factors. It is not good enough, according to the ESG advocates, that ESG factors are not given preferential treatment.

The idea of formalising ESG investment as a gate-keeper filter has been around for a while. About 10 years ago, the United Nations initiated action to develop a set of principles of responsible investment. There are 6 principles http://www.unpri.org/about-pri/the-six-principles/

The first principle is just a statement of common sense and, by the way, has been common practice for all investors since before the time of the South Sea Bubble. All professional investors take all factors into account when investing, but they quickly figure out the important ones. In practice, they find out the key advantages and disadvantages of an opportunity, relative to the next best opportunity, before deciding.  Investors do not ignore ESG factors if they are of sufficient importance. Principles numbers 2 through 6 are more problematic. They look more like ideas for group activism than responsible investment. Why are they needed other than to badger and cajole?

There is a major problem with the whole concept of responsible investing – who decides what is responsible? What looks responsible to you, may look irresponsible to me. Why should my view be more correct than yours? Should executive remuneration be linked to corporate action to reduce climate change? How about linking the bonuses to ensuring meaningful participation of indigenous people in a mining area? How about workplace diversity? How are these tests measured? Little wonder there is a lot of heat in the debate.

There is a place for zealotry in the investing world and that is when the zealot is investing his or her own money. There is no place for zealotry in the investment world if you are investing money that is not yours. Investors should take ESG factors into consideration along with all the factors that they consider but they should not elevate an ESG assessment first as a filter to simply remove altogether some potential investments.