- ESG funds saw outflows for the first time in their history last year, and the trend extended into this year.
- Alvarez & Marsal: we expect to see a decline in ESG-related campaigns and a renewed focus on metrics such as margin growth, cash generation and return on capital.
- The backlash against ESG investing overlooking physical reality is likely to continue for the foreseeable future.
Environmental, social and governance (ESG) investing has been touted as the mainstream investment style of the future—a more responsible but not less profitable future. The touting, however, went a bit too far, sparking an opposite and equal reaction, helped by the fact that ESG investing didn’t turn out to be as profitable as promised.
ESG funds saw outflows for the first time in their history last year, and the trend extended into this year. This was hardly surprising given the performance of most ESG industries out there, meaning wind and solar power. Somewhat ironically, European investors turned to defense stocks as an ESG investment, despite the industry’s negative impact on the environment. The argument made by governments promoting defense stocks is that defense manufacturers are positive in the social aspect.
Yet the most contentious issue in ESG investing has always been the traditional energy industry, also known as oil and gas. The knee-jerk reaction of ESG advocates is that oil and gas have no place in an ESG fund or an ESG investment strategy. According to some, however, this complete denial of oil and gas was the single worst thing those advocates could do—for their own hopes and ambitions.
“There were all of these idiots that were just saying, if anyone is doing hydrocarbons, we’re going to blackball them from doing business or from receiving capital,” hedge fund veteran Kyle Bass told Bloomberg this week. Apparently not fond of mincing his words, Bass also said, “And so Texas lashed back and said, if you’re going to blackball someone that’s producing hydrocarbons, we’re not going to do business with you either.”
This is as simple an illustration of how Newton’s Third Law works as can be. The pressure on institutional investors to dump oil and gas holdings has indeed been strong—and coming from other institutional investors with a transition-centric agenda. That was the action. The reaction, as demonstrated by the Texas authorities, was only a matter of time; as was a reconsideration of investment goals that is currently in progress.
Earlier this year, consultancy Alvarez & Marsal reported that activist investors were less likely to engage in ESG campaigns this year after they proved to be markedly less lucrative than campaigns that focused on effecting operational or strategic change.
“As investors focus more firmly on returns in 2024 in a challenging market, we expect to see a decline in ESG-related campaigns and a renewed focus on metrics such as margin growth, cash generation and return on capital,” Alvarez & Marsal managing director Andre Medeiros said at the time.
There’s more, too. Late last year, Deutsche Bank’s chief investment officer ESG, Markus Mueller, said that oil stocks should actually be included in ESG funds. “When we think about clean energy, these are business models which are quite new and sensitive to interest rates,” Mueller told Reuters. “Investors are looking for traditional [energy] companies that have capex in renewables… They prefer the transition than to exclusions.”
So, investors are waking up from their ESG dream and returning to real life—and a collision course with climate activists who, according to Bass, “think we can just turn hydrocarbons off and turn on alternative power. But they have no idea how the grid works and no idea how business works.”
Indeed, it bears noting that even such a transition champion as the International Energy Agency a couple of years ago called for more oil and gas exploration and higher production in order to satisfy the growing demand for energy, acknowledging how vital hydrocarbons are for the functioning of modern civilization. Activists and like-minded governments, however, tend to overlook such facts as they focus on catastrophic predictions that quite often fail to materialize in order to encourage more investments into so-called transition technology.
As Mueller’s and Bass’s statements suggest, however, activists can cherry pick their facts all they want, but bankers don’t have that luxury. It was no coincidence that a number of high-profile banks and other financial institutions have, in recent months, left various net-zero associations aiming to encourage/force their members to put their money where their mouth is on emission cutting.
“Skirting hydrocarbons is like bringing politics into investing,” Bass told Bloomberg this week. “If you’re willing to give up returns for that, then so be it. But I think that’s naive and it’s a breach of fiduciary duty.”
Indeed, investment firms have a fiduciary duty to their clients, and they should be able to override it because their managers are concerned about the amount of carbon dioxide in the atmosphere. Yet this is exactly what some investment funds are doing—and they are getting sued. In Texas, of course, they are getting blacklisted, as they are in other states that take their Third Law seriously. The backlash against ESG investing overlooking physical reality is likely to continue for as long as that denial of reality continues among ESG advocates.
