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ESG Investing: It’s Not Easy to Invest with Heart

 

Environmental, Social, and Governance Investing, or ESG is a hot topic right now.  You may have seen ESG options in your employer’s retirement plan, or advertisements for this “style” of fund or index.

 

What the Heck is ESG?

ESG is a Wall Street trend that gets beyond just financials by looking at how corporations address broader societal goals.  It asks: how is this company functioning as a citizen?  This thinking evolved from the idea of corporate social responsibility.

The idea: a corporation has responsibilities beyond answering to shareholders, and shareholders should want to invest in companies that are good citizens because focusing on all stakeholders is good for society, and good for a sustainable bottom line that looks beyond just the next quarter.

This idea has been boiled down to three big categories: environmental concerns, social concerns, and governance concerns.  Let’s take a quick look at each of these:

Environmental Concerns

These include the topics of climate change and environmental sustainability.  It looks at the impact a company has on global warming and natural resources.  The thinking: current environmental trends are unsustainable.

Social Concerns

These include: diversity, human rights, consumer protection, and animal welfare.  If you’re thinking it sounds like this could get political, you’re right, and it’s more tedious than it sounds.

Corporate Governance Concerns

Topics are wrapped around management structure, employee relations, and compensation.  The question this gets to: how is the company managed, how does it treat employees, and how is everyone hired by shareholders paid?

What Does ESG Investing Look Like?

Without getting into the weeds, you can see how these topics may be important to an investor.  We have a classic situation, an investor need has been identified, and Wall Street has cooked up a solution for you!  Is this out of the kindness of their hearts, or out of grave concern for these topics?  Of course not, it’s to get paid.

Wall Street has been in the process of building ESG indexes, ESG funds, and ESG ratings.  Here is a simple example.  They will take something like the S&P 500, the 500 largest stocks in the US, an important bellwether, remove stocks based on “ESG factors”, and then sell you an ESG fund that costs more than an S&P 500 fund.  Now, the thinking goes, you are a responsible investor, and now you can sleep better at night knowing your investments are making the world a better place.

Of course, it’s too good to be true.  Let’s look at why.

The Problems With ESG

In May Tesla was removed from a popular ESG index because of issues with “rampant racism,” and crashes associated with autopilot technology.  Racism is never justified, and faulty safety technology that kills people is never a good thing; however, it’s hard to debate that Tesla has been significantly moving the needle on auto carbon emissions with it’s own vehicles, and by forcing competitors to quickly come up with electric vehicle offerings.

If you take this one example, and imagine how environmental, societal, and corporate governance issues may intersect through a single lens that tries to boil a very complex ocean, the entire proposition becomes dicey, especially for an investor whose primary goal is to earn a good return, which is all of us.

From a recent Harvard Business Review article: “It’s long past time we faced a hard truth: despite a historic surge in popularity, ESG investing will not tackle our generation’s urgent environmental and social challenges…Yet it’s hard to blame casual observers for believing that investing in an ESG investment fund is helping to save the planet.”

From The Economist: “although ESG is often well-meaning it is deeply flawed.  It risks setting conflicting goals for firms, fleecing savers and distracting from the vital task of tackling climate change.  It is an unholy mess that needs to be ruthlessly streamlined.”

These examples go on, and of course in the current political climate ESG is painted as a vast left wing conspiracy.  There have been a slew of op eds in the Wall Street Journal to this point.

Another related issue that is seldom discussed, bonds.  Most of the ESG discussion focuses on the stock holder perspective; however, a diversified investor owns bond funds as well.  A bond holder is still providing capital to corporations.  There are far fewer ESG bond funds, and this type of analysis in the world of bonds is even more complex.

In a time of low yields, bond investors have less flexibility given the performance required from the bond side of a portfolio.

Considerations for a Concerned Investor

The important point here is to not simply invest blindly in an ESG fund, and believe you are somehow achieving a personal goal related to what’s important to you under this broad ESG umbrella.

The ESG funds are twisted and contorted when it comes to the goals they are trying to achieve; therefore, any single goal that is important to you may or may not actually be achieved.  To make matters worse, your returns may suffer compared to conventional funds, and those differences add up over time.  Don’t forget, you’re also paying higher fees for this privilege.

 

The Economist, a very old and conservative British newspaper, had one conclusion: “ESG should be boiled down to one simple measure: emissions.”

If this topic is important to you, there are funds available that only address climate change, and this kind of laser focus can be successfully achieved for certain parts of a portfolio, namely indexes of large US companies.  Attempting to bring this focus to other areas such as small company stocks, international investments, and bonds quickly becomes a more complex proposition.

The bottom line is that your long term wealth is too important to risk the gamesmanship and conflicting interests in the current world of ESG funds.

Please reach out if you would like to discuss ESG funds, or funds that may tackle specific issues that are important to you.

 

 

Buoyant Financial, LLC is a registered investment adviser located in Charlotte, NC. Buoyant Financial may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements. A copy of Buoyant Financial’s current written disclosure statement discussing Buoyant Financial’s business operations, services, and fees is available at the SEC’s investment adviser public information website – www.adviserinfo.sec.gov or from Buoyant Financial upon written request. This note is for informational purposes only, and should not be construed as investment advice, or a recommendation to buy or sell securities. 

Strange Times: Where Do We Go from Here?

 

We’re at a fascinating crossroads in the world of investing, and in many ways, a truly unique place.  While the adage: “this time it’s different,” always gets burned by the markets, this time, we’ve never been here before.

The best news: we’re almost near the end of the pandemic.  The good news: the economy is screaming thanks to unprecedented monetary (the Fed) and fiscal (Congress) stimulus.  The strange news: things are really out of whack in the markets, and this has quickly become visible in everyday life.

Lumber and building costs have skyrocketed, some things are still hard to find in the grocery store, and there are plenty of job openings, yet a high unemployment rate.  There are also strange things like “meme stocks,” and skyrocketing crypto currencies nobody had heard of until three months ago.  Let’s peel back the onion a bit.

So Much Money

Eight TRILLION dollars is a lot of money, and that’s a rough estimate of what has been dropped on the US economy by the Fed and Congress since the pandemic started.

The US government has sent checks to individuals, boosted unemployment, and supported almost all businesses in a variety of ways.  The Fed has been printing money to the tune of an additional $120 BILLION every month.

While the pandemic raged, the nation attempted to keep everyone and everything flush with cash to minimize economic fallout, but this process set up some strange dynamics.

Inflation

As the economy recovers from the pandemic, shut downs, and lock downs, money is once again flooding into goods and services as life returns to a new normal, and pent-up spending plays out.  The economy is whipsawing from the tremendous drop in output we saw last year to something approaching pre-pandemic right now.  That wave has a tremendous amount of momentum.  Economists were aware this was happening, yet inflation still came in four times higher than predicted last month, raising many eyebrows.

We’re now seeing prices increase in everyday life, coupled with businesses raising wages and offering incentives to attract workers, which also stokes inflation.  What do the financial markets say about this?

The Bond Market

The bond market tends to be intelligent, the smartest money in the room.  The Fed’s message to the bond market has been: this wave of inflation is just a wave, and with the economy getting back to normal, inflation will return to long term averages soon.  The bond market has priced this in as the absolute truth, because it is the absolute truth.

If inflation gets out of hand, the Fed will increase rates quickly, and force inflation back to long term averages.  If you’re old enough to remember double digit mortgage rates from the 1980’s, you’ve seen the Fed do this in real time.

The risk: the Fed doesn’t react quickly enough, is forced to increase rates faster than anticipated, and chokes off the current expansion, possibly creating a recession.

The Stock Market

The stock market is “all in.”

In the world of “blue chip” stocks (think S&P 500 and Dow Jones Industrial Average), the market is behaving as if rates will stay low forever, and the current expansion will never end.  It’s overpriced by most historic measures, and more money is ending up here because it has no other place to go with bond yields so low.

Then we get to strange places like “meme stocks.”  The current example is AMC.  The price of AMC increased by around 400% in one month when nothing really changed in the business of movie theatres.  In the normal investing world this would have meant that AMC figured out some new technology, created a monopoly, or found tons of gold buried under a theatre.  We’ve seen examples of this blind speculation recently with GameStop and others.

We’re at one of those places that feels like the dot com bubble where everyone seems to be trading stocks online, and making a killing because everyone else is buying like mad too.  Remember companies like: Ask Jeeves, eXcite, and Geocities?

Other Strange Things

The crypto currency space is frightening, and this won’t end well.  It’s difficult enough to justify Bitcoin, but these other crypto currencies, spiking almost randomly, make very little sense.  Much like the AMC example, people are dumping their freshly printed money into crypto currencies. What is the long term purpose of these strange coins?  They pay no interest, offer no dividend, and have no real utility.

The list of strange things goes on with things like tokenized art (non-fungible tokens or NFT’s), and SPAC’s, which are “blank check” companies, I give you money, and then you tell me what I bought.

Wrapping It Up

We’ve never been here, but some of these things look oddly familiar, and it’s strange to have them in the same room at the same time.  Inflation may or may not take us back to the 80’s.  Stocks may or may not take us back to the dot com bubble of the 90’s.  Strange things may or may not take us back to Beanie Babies, and Cabbage Patch Kids.

But, we’ve never been in a place where humanity is coming out of a gut wrenching pandemic with so much money to spend, and not enough places to put it.  This will surely end badly for some.

If you’re a regular reader of these blogs, you already know the punch line.  A balanced, diversified portfolio will weather whatever comes as this unprecedented wave in the financial markets passes, and serve you well in the post pandemic new normal on the horizon.

Not as exciting as a Dogecoin, but just as cute, and you’ll sleep well at night.  Please let us know if we can help, we’re here to help answer your questions.

 

Buoyant Financial, LLC is a registered investment adviser located in Huntersville, NC. Buoyant Financial may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements. A copy of Buoyant Financial’s current written disclosure statement discussing Buoyant Financial’s business operations, services, and fees is available at the SEC’s investment adviser public information website – www.adviserinfo.sec.gov or from Buoyant Financial upon written request. 

 

A Rocky Road to a Bright New Year

Despite the pain wrought by the virus, there is finally a light at the end of the tunnel.  The virus forced many of us in the investing world to become armchair epidemiologists since it’s nearly impossible to look at the economy without looking at the virus too.  

When I wrote about the pandemic in the spring, some of the models were showing numbers that seemed impossible, and by September those enormous numbers seemed even more impossible.  Unfortunately, we’re now living in a world where those painful numbers have become reality.  

The good news: we’re on a bright path forward thanks to effective vaccines being rolled out in real time.  A new normal finally seems within reach.     

We’re not looking at a setup for the greatest year the markets have ever seen.  As with the rest of our lives, we’re looking for a new normal, a post virus world that looks more like what we remember.  It will take at least two years for the economy to really move past the virus when you look at interest rates, unemployment, inflation, and volatility. 

Since the recession wasn’t driven by a financial meltdown, the monetary and fiscal stimulus measures were quite potent and effective.  But, these measures come with the price of having to be “unwound” over time.    

The stock market is currently overvalued by almost every measure, which was caused, in part, by irrational exuberance coupled with extremely low interest rates.  We’ll probably see a pull back, and that’s not all bad since we ultimately want assets priced rationally (there really is such a thing).  

As the virus is slowly brought under control, and our lives return to a new normal, there will be an increase in demand for products and services, which will be a source of economic strength.  This demand will push corporate earnings up, and at some point in 2021, stock prices and the underlying corporate earnings will meet closer to long term averages.  

A new normal will take longer in the world of interest rates.  The Fed promised that rates will remain low for years, and history tells us they will make good on that promise.  The downside: we could see real inflation for the first time in decades; however, it should be easy for the Fed to quickly tame any spikes above target.  

From a bond investor’s perspective, it’s important to keep in mind that if inflation goes up 1% and bond yields go up 1%, you’re in the same place, you’re not really enjoying a higher yield.  Inflation will be important to watch given the amount of money “printed” this year.  

After the tragedy of 9/11, things were never quite the same again.  There was a new normal, and with time, the trauma passed, receding into history and memory.  The post-pandemic world is likely to be similar, things will never quite be the same again, but with time we’ll reach a new normal, and this period will fade into memory. 

I wish you happy and boring holidays in the hopes that a subdued holiday season this year will give us many more in the future!  Please follow best practices around all things pandemic, such as avoiding large (or any) gatherings, wearing a mask when you’re out and about, and when the time comes, please get those shots.    

Buoyant Financial, LLC is a registered investment adviser located in Huntersville, NC. Buoyant Financial may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements. A copy of Buoyant Financial’s current written disclosure statement discussing Buoyant Financial’s business operations, services, and fees is available at the SEC’s investment adviser public information website – www.adviserinfo.sec.gov or from Buoyant Financial upon written request.