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.
Monogram Capital Management Ltd