November 13, 2012
Who wouldn’t want a cleaner environment or a more just society? We can all agree these are worthy goals. But it’s an established fact that pursuing them through one’s investing is costly; environmental-, social- and governance-based investing (ESG) does fine on a gross basis, but loses money net of fees. Now, a recently published paper argues that that ESG is basically a waste of time.
The paper, Misadventures of an Irresponsible Investor, appeared in the fall issue of the Rotman International Journal of Pension Management, authored by Jack Gray, a respected scholar at the University of Technology in Sydney, Australia.
Gray wrote from the perspective of a pension plan manager who wants to fulfill his fiduciary responsibilities and invest in the best interests of the plan’s members. His forceful logic, though, applies no less to financial advisors managing individual client portfolios.
The central question on which Gray’s paper focuses is whether managers can fulfill their duties under the Sole Purpose Test while simultaneously investing in a socially responsible manner. The Sole Purpose Test requires fiduciaries to manage assets solely in the interest of fund participants and for the exclusive purpose of providing promised benefits.
Gray has his dissenters – including, no doubt, some among our readers – but Gray doesn’t shy away from their challenges; indeed, he included rebuttals from three investment professionals in his article. I’ll cover those counterarguments, but first let’s take a closer look at Gray’s provocative thesis.
The dark side of being socially responsible
Gray, who has personally served on the boards of a number of pension funds, listed a number of ways in which ESG compromises their fiduciary responsibilities.
“A hallmark of committees is a predilection for avoiding difficult and uncertain tasks by instead focusing on those that make committee members feel good, or those that solve a problem well chosen for its simplicity and immediacy,” Gray wrote. “ESG offers scope for both avoidance techniques.”
For example, a board might spend time searching for “well-groomed” investment opportunities to fulfill its ESG mandate, and overpay for the privilege of owning what the search turns up, Gray said. He sees boards behaving this way particularly often in emerging-market investing, where opportunities to invest in attractively priced and well-governed companies are bypassed in favor of those that meet ESG criteria.
Gray wrote that some fund managers adopt ESG compliance as a “marketing ploy” to protect their careers, or because they fear losing business if they don’t.
But he was even more critical of those who make irrational decisions because they embrace ESG religiously, as the sole and dominant investment issue. He related one experience of a board that wouldn’t short a tobacco stock – an action which would have helped their moral cause – because they wanted “nothing to do with tobacco.”
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