Tag Archives: tradeoffs

ESG and Tradeoffs

Cliff Asness has the class piece on how ESG might sort of impact corporate decision making when it comes to climate change in “Virtue Is its Own Reward: Or, One Man’s Ceiling Is Another Man’s Floor.” Negative screening is not a free lunch. “Accepting a lower expected return is not just an unfortunate ancillary consequence to ESG investing, it’s precisely the point.” Higher returns for non-ESG investors are the other side of a high cost of capital for offending firms.

Matt Levine expands on the idea in a discussion of how a fund manager was coached by his sales team to answer questions about how a new ESG fund actually reduced emissions.

The first paragraph hits the same notes as the above summary. The second paragraph is a good admonishment of green washing of ESG investing that asks for no tradeoffs.

One is the answer [to how an ESG strategy reduces emissions] that Fancy gave to his client: “This low-carbon fund reduces emissions by raising the cost of capital of high-carbon emitters, leading them to shift to lower-emissions businesses.” This is an appealing theory because it makes some rough sense as a matter of economics. It has problems though. For one thing, you have to have a lot of low-carbon funds to meaningfully increase the cost of capital of high-emissions businesses; it’s not like any one fund manager — even at BlackRock — can point to coal companies that he put out of business just by refusing to buy their stock. For another thing, “raising the cost of capital of high-carbon emitters” means increasing the returns on their stocks, which implicitly means ”our ESG fund will get a lower return than a non-ESG fund, because we hope to raise the returns of non-ESG stocks.” This answers the client’s question — ”how does this fund reduce emissions?” — but not necessarily in the way that the client wants to hear: “We reduce emissions by giving you a lower return on your investments.” You can see why the salesman might have been mad.

The other theory is: “This low-carbon fund profits from the coming long-term shift to clean energy, giving it a higher return than funds that foolishly invest in fossil-fuel assets that will be stranded when regulations and societal norms change.” That tells the client a good story — “you can do good and make money too” — but, you’ll notice, doesn’t answer the question. “How does this fund reduce emissions?” “It profits when governments move faster than expected to regulate emissions.” “Yes but how does the fund cause that to happen?” It doesn’t, really.

Tradeoffs: Growth / Stagnation

If the cold calls aren’t about non-existent accidents, they’re about my computer viruses, unpaid tax, my pension, or the impending disconnection of my broadband. Fraud and mis-selling are on the rise.

Why? Because in a world of secular stagnation there are fewer legitimate business opportunities – which diverts some entrepreneurs towards crime. Of course, some people are wrong’uns who’ll be fraudsters anyway, and some are moral paragons who never will be. At the margin, however, costs and benefits determine behaviour and so stagnation promotes fraud.

Good Stumbling and Mumbling post laying out examples of the negative impacts of a stagnating economy compared to a growing one. Stagnations shifts many tradeoffs towards the undesirable end of the spectrum:

  • Entrepreneurship shifts towards fraud
  • “Normal” valuations shift towards detached-from-fundamentals valuations
  • Accessible housing stock shifts towards speculation over limited property
  • Open access to career opportunities for the less traditionally credentialed shifts towards exclusive hiring tracks
  • Positive sum politics shifts towards zero sum politics

Which is why I can’t support the de-growth movement. Shifting from (say) 2% to zero trend growth isn’t merely a small difference in degree. It has all manner of cultural and political effects, many of them unpleasant. And of course, there is a constituency which supports this – not just financial and political grifters, but social conservatives, (some) home-owners and parts of financial capital which profit from the ultra-low interest rates caused by stagnation.

What we need is an alternative to this – one which sees that the cause of many of our social and political problems is capitalist stagnation, and which offers an alternative to this. This need not be a very leftist programme: it should reprise Blairite themes of modernity, hope and optimism. Such a project, however, requires an opposition – which we do not have.

Not all growth is created equal but I will take growth over stagnation every time.