Fair trade coffee, quality certification and responsible investing

At the centre of each of these topics lies social activism that always progresses to economic rent-seeking. They start when certain people have a view that a market is failing in some way. Those people make their own judgement and decide that they want to change the particular market. They want to impose their views on the market participants. For example, in fair trade coffee, the central aim is to improve the working conditions and reward to local farmers and labourers in coffee growing areas. In quality certification, the certifying authority believes it is better able to judge quality than the consumer and so its stamp of approval adds an element of protection to the buyer. With responsible investing, the picture is a little confusing at present. Responsible investment agents are not clear on their value proposition – on one hand they present their case as ensuring (their) ethics are brought into the investment decision and so certain investments will be automatically excluded. On the other hand, they try to present this approach as good for investment returns. Well, it can’t be both. More on that later. Continue reading

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.

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