What are the costs of ESG? Untenable risk and an evisceration of fiduciary duty
By Mark Neuman, CIO/Founder of Constrained Capital
What are the costs of ESG? Untenable risk and an evisceration of fiduciary duty.
By Mark Neuman, CIO/Founder of Constrained Capital
How do capital constraints of ESG impact companies and raise costs, lower returns? Consider when Hershey’s is pushed to comply with E.S.G. and pursues “sustainable” chocolate. Misallocation of capital and malinvestment results. To pursue sustainable chocolate, the company needs to turn over more rocks to find cocoa or sugar sources. Producing the chocolate becomes more expensive.
How does it impact the consumer? For starters, it raises the cost of the chocolate. Is this consumer seeking out chocolate or “sustainable” chocolate? For a moment, ignore the labor practices in places like Brazil or Cote d’Ivoire. Let’s focus on pursuit of “sustainable” and effects on consumer demand. Everyone makes choices. This practice shows higher costs with negligible, possibly nil, consumer impact.
Who’s affected most? Are shareholders agreeable to lower margins and muted sales’ effect? Is society measurably better off due to forced mandates? It’s debatable and hard to measure and prove. Shareholders’ wants and wishes are lower on the priority list than others in the affected groups.
What drives Hershey’s sustainable initiative? Peer/societal pressure? An ESG due diligence questionnaire? Access to better funding? To say good things like, “Yes, we are ESG,” in compliance with the narrative? Is the tradeoff compliance or public shame? The answers to these questions imbue Blackrock’s “forcing behaviors.” Has BLK infiltrated the Hershey C-Suite (they own 7%.) Is the CEOs compensation linked to ESG compliance and initiatives? Is the CEO making decisions based on ESG- related comp, irrespective of HSY’s stock price? Who ranks where in the fiduciary duty lineup?
For the record, Hershey’s stock is up 60% in the past 2 years. Chocolate and food have inelastic qualities and could be relatively “inflation protected.” Or is HSY moving higher in the rising ESG tide due to market reflexivity? Hard to say. Impossible to quantify. Flows towards Hershey’s may have increased as they pursue “sustainability” rather than overall improving financials.
The HSY financials don’t show a 60% improvement over the past 2 years. Can we separate direct from spurious correlation? ESG is rife with higher costs, lower returns, and increasing risks. Is that priced in?
Net/net, is ESG the best result for society and investors? One could argue ESG is image-based. It starts with saying good to get better scores than truly doing good for actual societal benefit. Add in costs as a tax on the company, the consumer, and the shareholder. Who benefits the most? These questions remain up for debate. If CEOs are paid according to ESG initiatives, we know who is atop the beneficiaries’ list.
The Hershey’s ESG example is a medium/long term consideration. We see more immediate ESG negative impact highlighted recently by Budweiser (BUD.) BUD veered from its lane and drove onto the ESG roadway. Whether or not the CEO knew about the marketing ploy is debatable (and questionable “G” governance to boot!) This was a clear attempt to raise ESG visibility. It cannot be understated that more than 80% of S&P 500 companies CEOs have their pay tied to ESG initiatives. Was that at play?
Before moving forward, let’s clarify a few things: 1) BUD is an ESG Orphan aka an exclusion of the ESG bubble. Its main product is alcohol. Heretofore mostly left out of the past decade’s ESG asset inflation.
2) It’s likely BUD has received the short shrift of financing deals because banks are encouraged to refuse good financing to those with bad ESG scores. Was BUD trying to assuage negative ESG scores? 3) How did BUD shareholders/investors fare?
We’ll address #3 first: Q2 sees BUD -18%. In the preceding 6 months, BUD was +50%. Maybe it was just a price correction in BUD. But the cynics say, it was an ESG-forced business decision error that started the cascade. They would not be wrong. Investors voted with their wallets and exited BUD. Back to our oft repeated phrase, “ESG raises costs and lowers returns.” BUD’s price action is short-term confirmation. Debating “seen or unseen” ESG costs and risks is fine, but the price action is immediate. We’re old-school like that; the scoreboard matters. BUD -18% since the marketing fiasco speaks volumes. For comparison, Constellation Brands (STZ) recently made YTD highs and is +10% in Q2.
Now on to the other two items (BUD being an ESG Orphan and BUD getting bad financing deals.) These are part of the ESG imposed constraints and forced corporate headwinds. Money flows are circumventing BUD on ESG bubble exclusion. Bad financing deals raised their cost of capital. Money center banks play along to help their own ESG scores. Disadvantage BUD. Investors suffer as dollars are arbitrarily stewarded into “ESG good” companies and steered away from “ESG bad” ones. Winners and losers are handpicked by the ESG narrative. The BUD story was 2 months ago now. Another one just popped up with Target (TGT.)
TGT jumped right into the ESG swamp. They aggressively entered the LGBTQ+ foray to highlight their “ESG” efforts. This ostracized nearly everyone who shops at TGT. The stock has been in freefall since.
Looking back at price action history reveals that in May 2022, an earnings’ miss shaved 30% in market cap quickly. For about a year, TGT consolidated in a 15% range. Their recent loud statement in LGBTQ+ blew apart their audience, ended the price consolidation, and sent TGT to new lows.
The stock was massacred, closing lower for 9 straight days, and shedding 21% in 2 weeks. Walmart and Costco are down 4% and up 1% respectively over that time underscoring the TGT-specific nature of the selloff. The ESG-driven marketing effort destroyed the stock. It divided the entire customer base. Store bomb threats were made. Bomb threats are when I stop patronizing a store, I have my limits.
Now we ask the question: Is Brian Cornell’s compensation tied to ESG initiatives? Has TGT’s bottom line and/or stock price been rendered less relevant than TGT’s ESG actions with respect to Cornell’s payout? The ESG capture in the C-Suite is pervasive these days. Blackrock repeats, “We’re forcing behaviors.” Blackrock owns 7.5% of TGT.
Forget TGT’s choice of clothing or displays. I avoid picking political sides. I steer away from it when discussing ESG. I focus on the CFA charter holder angle, homing in on risk/reward and fiduciary duty. If investors maximize returns, they can use those proceeds to pursue personal ESG interests. Politics and emotion soil investment judgment. Unfortunately, ESG trends are rendering fiduciary duty moot.
Target and Budweiser learned this the hard way. Their stock prices have crushed investors. Customers are angry and disappointed; they are boycotting. This destroys the idea of beneficial results of ESG compliance and virtue signal. The developed narrative imposes on everyone while threatening social, political, and financial ostracization. Inaction or action seems like a Catch-22.
TGT and BUD did what they thought was the right thing, perhaps they were incentivized to do so. It did not end well.
The past 18 months exposed ESG shortcomings. A lot of it is self-induced by forced myopic decisions (behaviors.) Costs are higher, returns are lower, risks are huge. Many narratives are on false pretenses. The greater damage is revealed in risks, in part due to a false sense of security that ESG creates.
Recently it was Target and Budweiser. Before that it was Silicon Valley Bank (SVB) with a “Medium” ESG risk stamp. A bank with no Chief Risk Officer is an abject zero in “G.” Imagine a 3-legged stool absent one leg. That’s 100% risk. Nobody would sit in that stool. SVB began the “Banking crisis of 2023.” Everyone ignored risk due to a good ESG score. It ended in disaster.
Prior to SVB, it was FTX. FTX scored higher on some ESG metrics than the ultimate ESG villain Exxon Mobil. Sam Bankman Fried mocked the ESG “shibboleth.” Industry luminaries from hedge funds to private equity to venture capital to pension funds heard the “ESG” acronym, saw the crowd involved, stopped the due diligence, and joined the party. Logic left the building. Risks were papered over and ignored. Soon thereafter, the game was over!
ESG shortcomings are as numerous as proposed benefits. Unfortunately, investors don’t hear both sides of the story. We’ve seen the costs of ESG, and the exploding risks associated. It feels like there will be more cockroaches soon to scurry. The ESG movement built up for so long. The seeds have been sown; the roots run deep. There’s no ESG panacea, despite what the narrative suggests.
ESG is ubiquitous. Heed should be taken to understand the effects of misallocated capital and malinvestment. The ESG shiny object has distracted investors from shortcomings. ESG proponents focus on the fees (multi-BLNs) and continuing to expand the cottage industry.
I am not anti-ESG in concept or theory. As an outdoor-lover, and one raising a family, my concern for the environment and the longevity of healthy, clean living on this planet is right alongside any environmental activist. We act locally and support things globally. No plastic bottles in the house for over a decade. We grow our own herbs and vegetables. We live in a diverse community. But living an ESG life versus stewarding investors to make fully informed decisions about ESG risk are not the same.
I am anti-ESG gaslighting, misguidance, and power grab via regulation, peer pressure, and shaming. My CFA charter holder compass blew up with the destruction of fiduciary duty. Investors deserve better. False narratives and biased storytelling to advance someone else’s interests are a huge detriment to investors and society. Investors need to know the risks and rewards, benefits and pitfalls of ESG. Forcing behaviors doesn’t help companies or investors over long-time horizons. Risks pile up and then are quickly exposed. Easy money aides in trying to deliver preferred outcomes. It’s only a matter of time before piled up inefficiencies lead to untenable risks that boil over.
Many ESG narratives appeal to guilt, shame, and hyperbolized risks. Emotionally charged decisions lead to bad risk taking. We are seeing this locally and globally. It feels as if there’s more to come. The ESG build up has been happening for over a decade. The negative aftershocks have just begun.
We continue to focus on, “Truth in ESG.” Investors and society deserve to be informed, know both sides of the story, and make decisions based on transparent understanding of risk/reward.
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Mark Neuman CFA is the CIO/Founder of Constrained Capital and creator of the ESG Orphans Index. He is a leading ESG analytical authority and advisor to institutions and investors managing risk around ESG.
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Mark Neuman is a 30-year finance industry veteran with experience in senior roles at Merrill Lynch, Susquehanna International Group, Jones Trading, and Baycrest Partners in NYC, Philadelphia, and Tokyo, Japan. He brings expertise is in derivatives, macroeconomics, and global portfolio risk management. He was also a partner and head of trading at an event-driven hedge fund.
Recently as CIO/Founder, he created Constrained Capital to help investors identify opportunities where capital constraints have skewed risk/reward.
Mark Neuman, CFA
Constrained Capital Founder & CIO
917 658 9369
www.constrainedcapitaletfs.com
Twitter:
@ESGOrphan
@MarkNeuman18
Mark Neuman is registered with Foreside Fund Services, LLC which is not affiliated with Constrained Capital or its affiliates.
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Stephen Heins Biography
(929-918-8098), steve@heins.net, stephenheins@gmail.com
2009-20233 as the Practical Environmentalist
He is a radio veteran and has published dozens of articles and op-ed pieces on energy management, the utility industry and environmental issues for leading newspapers, energy and trade magazines including the Milwaukee Journal Sentinel, the San Diego Union Tribune, Engineering Times, Energy and Power Management, EnergyPulse and Electricity Today. Heins thinks that energy efficiency can play an important role in solving electrical power generation problems while helping companies reduce their carbon footprint. To that end, he was an associate member of the Midwest Energy Efficiency Alliance, a committee member and international committee member of the Alliance to Save Energy, a participating and white paper contributing associate to the American Council for an Energy Efficient Economy, a member of the Chicago Climate Exchange, a member of the Natural Resource Defense Council, an E4 board member, a member of the Wisconsin Manufacturers and Commerce Association, a member of the Association of Energy Service Professionals, a member of the U.S. Green Building Council, and a board member of the Wisconsin Industrial Energy Group.
In addition, he has spoken on emission reduction opportunities and emission trading at the Alliance to Save Energy International Conference in Paris, Chicago Climate Exchange Conference and the American Council for an Energy Effieicient Economy annual conference in CA.
Prior to joining 2001, Heins was director of marketing for NorthNet, an Internet Service Provider based in Oshkosh, Wis. During his three years, Heins published more than twenty-four articles on telecommunication, broadband and business issues. In addition, Heins was an important actor in “Stealing Time,” by Alec Klein, which was a book about the AOL/Time Warner merger published in 2003. All total, Heins was quoted in over 150 articles about the AOL/Time Warner merger, including the Washington Post, Wall Street Journal, Fortune Magazine, Business Week, National Journal, Philadelphia Enquirer, LA Times, USA Today, CNN Moneyline, National Public Radio and many other national and international media outlets. His quotes were translated into 9 languages.Merger was announced on January 10, 2000 and Memorandum of Understanding on February 29, 2000.
Before that, Heins was marketing director for Trautman-Kramer, a Wall Street investment banking firm specializing in private placement and mezzanine financing for emerging companies. His early career took him into the restaurant business managing a chain of highway restaurants. Also, he studied current American poetry at Columbia University and he is a published poet.
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