December 8, 2021
Mutual funds and exchange-traded funds based on environmental, social, and governance attributes (“ESG” funds) are gaining popularity and momentum in Wall Street.
Yesterday we shared with you the first part of Kim Iskyan’s story about “woke” investing and how it’s further permeating portfolios. He wrote, “There is clearly something missing in ESG investing. And the word that’s shorthand for that absent input starts with a ‘D.'”
Here’s the conclusion…
The Next Frontier of ‘Woke’ Investing, Part Two
‘D’ Is for Democracy
On December 9 and 10, U.S. President Joe Biden will host a virtual “Summit for Democracy” for representatives of around 100 countries. The aim of the meeting is to develop strategies and efforts to fight corruption, defend against authoritarianism, and promote human rights.
It’s on-brand for the Biden White House, which views much of its foreign policy through the prism of human rights and democracy. And it’s also timely, because democracy has taken a beating in recent years.
The Economist Intelligence Unit’s (“EIU”) Democracy Index measures the degree of democracy in countries around the world by assessing political participation, the electoral process, civil liberties, and other parameters.
And it’s not going well: In the 2020 edition, the global average democracy score hit an all-time low (since the survey began in 2006), as around 70% of all countries recorded a decline in their score. “Across the world in 2020, citizens experienced the biggest rollback of individual freedoms ever undertaken by governments during peacetime (and perhaps even in wartime),” the EIU warned.
And the decline “came about largely—but not solely—because of government-imposed restrictions on individual freedoms and civil liberties that occurred across the globe in response to the coronavirus pandemic,” the EIU explains. (The United States ranked just 25th out of 167 total countries, and earned the distinction of being a “flawed democracy” – below “full democracy” club members including, for example, South Korea, Germany, Uruguay, and Taiwan.)
The Missing Corporate Responsibility
Democracy slips through the cracks of the ESG framework. Human rights get a nod in the “S” category, while bribery and corruption – part of any form of government – are generally part of “G.” But “governance” in ESG refers to standards of running a company… not the country (or countries) in which the company operates.
But as important as environmental, social, and (corporate) governance factors are, they take a backseat to the role of the company in the stage that it’s playing on. As University of Chicago finance academic Luigi Zingales explained late last month…
Democracy… is a human right, which means the first social responsibility of business – be it a sole proprietorship or a multi-trillion-dollar company – is to refrain from undermining democracy, either at home or abroad.
The problem is that if democratic structures are flimsy, companies have scope to bend – or create – the rules by which they’re governed. The $306 million spent by the pharmaceuticals and health-products industry in 2020 wasn’t to make more fair, just, or safe rules and regulations that regulate their business. Instead, the companies in the sector – anyone with a “government affairs team” (aka, lobbyist) budget – wanted to convince the people in a position of power to change the rules, and to do so in a way that will improve their corporate bottom line.
Big business influencing government is as old as business, government, and money, of course. But democracy is already under unprecedented attack… and, meanwhile, companies – under pressure from investors – are paying lip service to values and to doing what’s right for the broader good. And they’re losing sight of the ball in the sun of their escalating profits.
It’s a grave oversight – even hypocritical – for ESG-focused investors to be concerned with how many trees a company plants, how many people of color a company has on its board, or how many restroom breaks employees get… while ignoring the underpinnings of everything else: how the rules are made, and the robustness of the government to implement policies that are designed for the good of the people and which companies in turn must adhere to – rather than for the companies that put them on the payroll.
As Zingales explains…
Not interfering with the democratic process should be the primary social responsibility of any business. ESG considerations are important; but if a company fails on the D (democracy) criterion, it doesn’t matter how well it appears to perform on ESG metrics.
Many Inconvenient Truths
Some of America’s biggest companies – with prominent positions in every index, and which noisily tout their ESG credentials – are also some of the biggest purveyors of gray-cash political influence. Facebook and Amazon are the biggest corporate lobbying and political contribution spenders (with more than double the outlay of even ExxonMobil and cigarette purveyor Philip Morris). According to consumer rights advocacy group Public Citizen, Amazon spent $18.7 million on lobbying in 2020 while Facebook, spent just under $20 million.
These are not efforts to support democracy. What they’re doing – lavishing attention on lawmakers to, ultimately, be able to make more money – is legal, according to the letter of the law. But it doesn’t take away from the fact that it very likely counters the values ostensibly espoused by ESG investors.
What’s more… the enormous representation of the biggest asset managers as shareholders of big companies gives them an outsized scope to influence corporate policy. According to The Dictatorship of Woke Capital: How Political Correctness Captured Big Business, three big asset managers (BlackRock, Vanguard, and State Street) together control, on average, 22% of the shares of companies listed on the S&P 500.
This raises “a host of very serious concerns — for investors, for consumers, for companies, and indeed, for American democracy,” author Stephen Soukup explained in the conservative National Review. (And that’s particularly true for those investors who don’t agree with ESG values.)
It’s even fuzzier when emerging markets come into the picture. Authoritarian China (which, as the genocide-d Uyghurs can attest, falls woefully short on the scale of human rights, among many other ESG measures) is home to the world’s second-largest capital markets. Vietnam, easily the current global investor’s favorite smaller emerging market, is similarly suspect on the “D” front. There isn’t a strand of democracy in the DNA of Russia’s Kremlin. Indian Prime Minister Narendra Modi is alarmingly handsy with power – while giving democracy a stiff arm.
BlackRock in particular has been a prominent banner-waver of the ESG flag, with CEO Larry Fink vociferously supporting sustainable investing. (Presumably the positive economics of ESG investing have nothing to do with his advocacy.)
But at the same time, BlackRock is also a rabid China fan. Over the summer, its research team recommended a heavy overweight position in Chinese shares. And, in June, the company became the first global asset manager to win regulatory approval to launch a wholly owned (that is, with no local partner) domestic Chinese mutual fund business. The internal inconsistency of these two positions – pro-ESG and pro-China – will soon come to haunt BlackRock and lots of other big would-be ESG investors.
What If You Don’t Give a ‘D’?
But as Tellimer explains, “Most investors demonstrably do not care much about democracy.”
And incorporating a “D” into ESG would be messy, difficult, and require facing up to contradictions to which there is no easy answer. What’s more, the extreme subjectivity and vagueness of gauging democracy – who is the arbiter, what are the standards, how is the data collected? – make the other components of ESG feel like they’re in 98-inch, 8K resolution by comparison.
But regardless of the challenges, the inherent contradictions in ESG investing by ignoring the country element – and the superstructure of government, and democracy in particular – will force a “D” reckoning. And one result will be that the investment universe for ESG investors will shrink… even more. In the meantime, while ESG investing is a growth market, most investment options are (for now, at least) still non-ESG.
And some go further to be explicitly anti-ESG, like the American Conservative Values Fund (ACVF). It holds a basket of S&P 500 stocks, minus those determined by the fund manager to undercut free speech and individual liberty by their “wokeness.” It’s a socially conscious fund, only in reverse. As of early October, the fund was not invested in Walmart because of its policy on the sale of guns and ammunition, nor was it invested in Apple, Nike, Amazon, Disney, or Starbucks for their “hostility to conservatives,” Newsweek reported.
Is that the future of ESG investing? Probably not. But there’s a lot of uncharted territory to be covered.
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Executive Editor, American Consequences
With Editorial Staff
December 8, 2021