ESG : Being All Things to All Men

I have been attempting to not write about ESG all year, as passions run high, and it feels to be more about faith and politics than Environmental Social and Governance (whatever that is) itself, as they encompass an incredibly wide set of issues, now being squeezed remorselessly into a few tick boxes.

However, I have been greatly enjoying Simon Schama’s magisterial tome on the Batavian Republic, as the Netherlands were known during what we loosely call the French Revolutionary wars. The analogies to the situation today are startling.

Can you Take a Position on ESG Issues?

In the environmental universe, I personally tend to be far more a “dark green”, than a “light green”, which in very crude terms holds that sustainability is not a matter of work-rounds with the “same as before” levels of consumption, but of a reshaping to avoid the extraordinary growth in raw consumption seen over my lifetime. More Monbiot than Musk, you might say.

Yet on trade, by contrast, I would ally strongly with the ‘Social’ part of it: nothing frees a nation like free trade, and nothing builds prosperity so fast. Just ask the Chinese.

A new Form of Colonialism?

Free trade also includes the free movement of capital, so that the relentless red lining of the most impoverished third of the planet on the grounds of failing to meet our Western standards of governance, feels very much like old colonial exploitation.

Effectively you’re saying – ‘yes, do sell what you like, made by who you like, using what you like, but just not to our markets’.

How can anyone be in one place on all of these often-opposing issues? If you are, the investable universe shrinks to nothing, or indeed paradoxically becomes everything. I have seen ESG bonds where China and Qatar were the top holdings, I am sure on perfect ‘E’ box ticking, but not my idea of either the ‘S’ or the ‘G’ part of it.

Governance, the most Elastic Concept of all?

While in my experience, few things have so powerfully increased inequality as remuneration committees, festooned in ways to line the pockets of directors, and singularly toothless in their stated aim. But all it seems fine on the weird ‘G’ criteria.

There are many other fraternal and earnest slogans now hiding deceit. Several of the current entrepreneurs most carefully cloaked in greenery and its social equivalent, have a decidedly old-fashioned view of governance, a fondness for non-voting shares and other tricks, and boards stuffed with their mates, which then also leaves the substance of the ‘G’ part well short of the mark.

So, to me ESG ends up as so wide, that an investor who really cares must pick and choose where to place the emphasis. Yet even this is seldom possible, in part because so many collective instruments are already being packaged in strict tick box compliance, which massively restricts your options.

The curse of all index investing is you end up taking a set of equities typically based on their market capitalization, so “desirable” stocks by definition end up in wider and wider sets of indices. As so much is now index investing, you are then forced to acquire both sheep and goats, with little chance of avoiding one and adding to the other.

However, as a fund manager you must always play a twin game, of either allocating capital to where it is most productive or allocating capital to where it is most popular. Clients tell you they desire the former, so they want good ESG credentials, but actually want to have the best return too, in other words the latter.

Governments, as China is now clearly showing far prefer (as they must) the productive to the popular. Popularity is proving dangerous in that market, as therefore is for now, index investing. Just as you pile into owning the latest media sensation, the state starts destroying it, almost a re-run of our experience in investing in UK banking.

All of which leads me to conclude that like anything else in markets, ESG can be good value, but can also be poor value; what it can’t be is always wholesome. Investors should realize that if it is not to be all things to all men, it must also ultimately cause them losses as well as gains.

I could add a line on Jackson Hole and Jerome Powell, but that is all that it deserves, nothing new was said.

I notice that he too has become, skillfully, all things to all men.

Charles Gillams

Monogram Capital Management Ltd 


Holiday reading – Simon Schama – Patriots and Liberators.

book cover of a book by simon schama, called patriots and liberators. Charles Gillams calls it a magesterial tome on the Batavian republic, and recommends it to his readers.
Book cover

Simon Schama unpicks the eternal power and politics questions, seen through the simpler although less familiar lens of the Dutch.  

I now finally understand what Camperdown was all about, so apparently it is not a racecourse, after all.

Although the Anglo Russian invasion of Holland remains mysterious, it does remind us how fleeting our alliances are.

The British showed considerable skill in repeatedly landing in Holland, looting the place, seizing much of the Dutch fleet, and then executing a negotiated evacuation, when they had clearly failed in their main mission of “liberation”, without too much embarrassment: an under rated skill it seems.

The sheer impossibility of nation building by force and myriad other democratic puzzles were exhaustively thrashed out by the Batavians, under the baffled eyes of the French invaders. Nothing changes, it seems.

While the sections on taxation and local government are rather strangely relegated to near the end, but feel to me, something of a connoisseur of both, perpetually modern. This was the period when the old inherited ways were first discarded, and our new ‘modern’ systems sketched in.

Their arguments over decades are now ours too. The clash of a European superpower and democratic freedom rings true still, the crippling burden of an overmighty, half blind and deeply corrupted centre remorselessly subverting the myth of its own creation by greed, the utter folly of war and the deep atavistic permanence of old boundaries are all visible.    


First posted on 10th January 2021

Attempting to comment on the last few weeks seems largely futile, save perhaps for the apocryphal remark attributed to Chinese premier Chou En Lai, that ‘it is too early to tell’, when asked about the impact of the French Revolution.

We suspect the markets are a little too relaxed about the assumption that Biden will spend furiously, effectively and in a way to spark inflation, but without any significant extra taxation or regulation. Lost in the exuberant desire by the market (and voters) for yet more debt are those inevitable downsides. While clearly the amount of speculative froth in the US market, is a clear warning of disaster to come; it never ends well when valuations get this daft.

As for these shores, it is not clear why it is almost mid-January, before the blindingly obvious need to vastly ramp up vaccination rates, for drugs that were available weeks ago, has only just penetrated Boris’s head. We are all rather immune to his elastic grasp of promised numbers now. Like the Relief of Khartoum, I suspect they will have dithered into disaster. Vaccines by the barge load will be coming in, just after COVID has over-run our defences.

It is reassuring to learn that the seven days a week NHS so touted by David Cameron, still remains a distant hope. And indeed, that this is not so much of a crisis, that vaccinating people on a Sunday can be contemplated. Over the next fourteen weeks that will cost a further fortnight of unforgivable delay. Luckily for the government, the EU is even more hidebound and inflexible, so we can claim a comparative victory.

Environmental, Social and Governance – an active conscience at work?

So, to a wider issue, the dear old ESG (Environmental Social Governance) standards to which all fund managers must now adhere. This seems to be largely (well intentioned) greenwash, it will not surprise you to hear. But we do have to start somewhere. JP Morgan have conveniently set out a simple guide on this, around whose elastic edges they must invest. We will shortly clamber through this.

The risk in ESG cuts several ways. From a market view, the damage comes from the familiar “buyers and sellers” equilibrium, which means every buyer needs a seller and vice versa; where the impact is profound.

Assume that most big liquid stocks grow into their positions over a decade or more, and therefore once in an institutional portfolio, they will also hang about in it for many years, think IBM or GE. Now suddenly condense that holding period into a far shorter span to dis-invest and you will blow the subtle price balance apart. By the same token, a company typical grows, acquires, improves over decades, just as companies like Apple and Microsoft have, plugging away and expanding. Now what happens if the demand for all the buyers of a decade or more, are suddenly packed into a few months? Again, that delicate price balance is destroyed.          

So, you can then easily model remarkable over or under valuations, based not on any core worth but on supply and demand. Now there is a whole new world of pain from this, if you get what is called “common ownership” which is the phenomenon of a trio of giant asset managers, who own 20% plus of the S&P 500 between them. So, if those asset giants decide to switch course, the volume of stock unleashed (or indeed acquired) will clearly be far beyond the market’s power to react in a balanced way.

The Democrats are already nervous about this feature, and may well look harder at it, although probably after a nasty market crash, of course, not before, when it might actually help.

ESG In Action

So, in JP Morgan’s definition, what is ESG? What does the “E” constitute? Carbon pollution and emissions, environmental regulations and adherence, climate change policies, sustainable sourcing of materials, recycling, renewable energy use, waste and waste management. Seems OK. Under the S we have to look at human rights, diversity, health and safety, product safety, employee management, employee well-being, commitment to communities. Fine too. While finally G is Board structure, effectiveness, diversity and independence, executive pay and pay criteria, shareholder rights, financial reporting and accounting standards and finally a catch all of how the business is run.  

So, it has become quite a narrow definition, although a little less so on the environmental side. It favours businesses that are not vertically integrated, those that just skim the last bit of others production. No direct mention of water or indeed of total consumption, in that part of the guidance for instance. Other areas also justify that late-stage business model, a focus on employees, but not workforces, on low skill workforces too (which are easy for diversity targets), no actual production (helps a lot on health and safety, to have no machinery), while ESG advisors love the soft option of ‘commitment to communities’, a couple of village halls and a sponsored half marathon and you are there. It is completely silent on fair tax.

Indeed, you can almost see this definition leaning into the big distribution, tax avoiding, gig economy US firms and most strikingly into fin tech. Maybe ESG is the after all the revenge of the bankers?

There are some traps in the G section, Board diversity and effectiveness are easy enough to fix, that’s what chairs of audit and remuneration committees and indeed HR directors are for, while Board effectiveness is always assessed by consultants they themselves appoint, we have seen some right turkeys ‘assessed’ as absolutely fine.

Independence used to mean something, but Cadbury et al have made that vacuous box ticking just related to tenure. Pay is sorted by a very low (or zero, for high grade virtue) basic salary and generous yet soft bonus targets, with personal targets again a great loophole. Mine are to try to do a good job (and yes, we have seen that actually used). I can certainly meet that before the year even starts. As long as you don’t set pay upsides too eye wateringly high, most things on remuneration still get nodded through.

A hollow laugh then follows for shareholder rights, with so many of the big tech stocks having odd voting structures. Financial reporting? Well, “adjusted” profits allow pretty much everything on that side now. Some conspicuous angst over valuation of goodwill or deferred tax or lease accounting, none of which have any impact on cashflow, also apparently counts for good accounting compliance.

So, the ideal ESG business would be something like PayPal, Visa, Verisign, Alphabet, Autodesk, Charles Schwab, in short fintech is simply delightful as it has no factories and makes nothing. Distribution is not too far behind. All cracking market performers too.

Is ESG then just convenient ‘tagging’?

Now that gets us back to “common ownership”, if enough big managers decide that’s the way to invest in what they like already, but they now simply tag it as sustainable, then there is a rush into those same stocks, which as we know then go up, more buyers than sellers time again. Magic, you have created both a market outperformer and an ESG winner and yet not stepped an inch beyond your comfort zone.

Well, each of those listed stocks above do indeed feature in the top ten of our very own sustainable fund holding, what a surprise! That also gives us performance, and we know exactly what our holders hire us for. Get enough buyers in line and any stock can be made to shoot up like a rocket. 

While just as ESG has been a perfect template for the overvalued US tech stocks and the cleverly presented top slices of the real economy, investment in that part of the globe where the 30% of the poorest people on earth live, has also dropped remorselessly this decade, helped down, by yes, ESG.

Just like the Victorians, we seem to believe that the poor must be clean to be helped, both literally to enter the workhouse, and figuratively to justify our assistance. If you ain’t clean, free of drugs and vices, and suitably docile, you are simply not the deserving poor.

So, we reject those dirty countries whose firms make up 5% of the world’s listed profits, but only 1% of investable assets. In other words, we are all 80% underweight in those so-called Frontier markets, you can guess where the compensating overweight is, of course.

Many such holdings are rejected because they run vertically integrated, job creating, people hiring, output generating, dividend paying businesses which are exactly those that are so despised by the neo colonialists on ESG committees, because they are both poor, and not yet clean. Only sinners that have repented can be helped, we do remain Victorian at heart. While their output, once sanitised by distance, can happily be the base for clean, ESG compliant, fintech services or advertising.    

When judgment is made to look like virtue

There are few better tools of subjugation than denial of access to capital and banking services, there are few better ways to keep colonies in check than protectionism, preferably founded on opaque, subjective rules. Just ask the British Raj about those devices.

Somehow that awareness has now crept into how the ‘ghetto’ poor are to be treated, but not into how the poor are treated globally. Yet we also know that the one remorselessly feeds into the other.

ESG has become a means of protectionism, of restricting access to capital for the poorest economies, but also a path to destabilizing our own equity markets, piling on volatility, mis-allocating capital. Well, you can’t fault good intentions, but as Boris so often demonstrates, good outcomes are not quite the same.

What the global poor need, is a shot in the arm from unfettered capital markets and an end to protectionism.

Keep an eye on what Biden achieves, with his “summit of democracies”, as colonies, much like ghettos, always adore being preached to with evangelical fervour about their own morality, especially by a country with such a vibrant, exuberant, healthy democracy.

Charles Gillams

Monogram Capital Management Ltd