The asset-management industry has been struggling for a while, but one category continues to attract assets: ESG, which screens companies for environmental, social and corporate governance factors. Put another way, it seeks to identify companies that strive to do the right thing. ESG-driven assets have now reached $40 trillion globally, which seems to have accelerated during the pandemic.
Q2 2020 hedge fund letters, conferences and more
This turns on its head Milton Friedman’s premise that companies should try to pursue profit above all else and in that pursuit will accomplish good as an externality. Though ESG promoters say that doing the right thing and making money go hand-in-hand, the current thinking says that making money through investments is incidental to doing good.
In recent years, ESG-related investments have consistently outperformed their counterparts. That, however, could be an accident — many ESG funds invest heavily in tech companies, and tech most likely is rallying for reasons that have nothing to do with ESG. Many ESG funds exclude fossil fuel investments, but fossil fuel investments could also be doing poorly for reasons that have nothing to do with ESG. Look closely, and it appears that ESG is just another old-fashioned stock market bubble.
ESG has become something of a self-fulfilling prophecy, driven entirely by liquidity and flows. Global ESG funds experienced inflows of $45.7 billion in the first quarter while the broader fund universe sustained outflows of $384.7 billion, according to Morningstar. The sheer magnitude of these flows can drive asset prices in different directions and create the appearance that ESG is working as a strategy.
What’s interesting is that ESG investing is having its intended effect — it is raising the cost of capital for “bad” companies and lowering it for good ones. If it continues, it just might result in the disappearance of the fossil fuel industry. As a libertarian, I can’t say I’m sad about this — this is a better, market-based way of doing it than any top-down edict. But it’s probably a short-lived phenomenon.
I think that ESG investing is in the early stages of a bubble — which means it probably has a few years to go before reaching sublimely ridiculous levels. Tech stocks just had a blow-off top, while Exxon Mobil just had its worst 30-day period in history. We are starting to see products that are almost comical in their attempts to avoid energy, like SPYX, the new S&P 500 ex-fossil fuels ETF, which combines the S&P 500 index with ESG. There’s a lot of hype and promotion, which usually crops up in bubbles.
Read the full article here by Jared Dillian, Advisor Perspectives
