A Perfect Storm Against ESG Investing

Ichiro Suzuki Over the past decade, the investing community has grown increasingly conscious of its impact on well-being of us who live on this plant earth, as opposed to unfettered shareholder capitalism that chases higher profit growth at all costs. Factors such as environment, society and governance were increasingly taken into consideration in investment decisions. Ardent believers advocate that ESG-conscious investing leads to higher returns. That is fine. There is no arguing against consideration of these things. Since the days of the Reagan-Thatcher revolution, neoliberalism has gone as far as it could. However, the real world is a bit more twisted than Disney animated films, in which a good guy always win over bad guys. At the very least, it takes good guys a very, very long time to win over bad guys, whereas good guys in films always smile after two hours. While energy giants in their current form are probably heading toward extinction over the long-term, this long-term is not three or five years. It could be well over ten years. In the meantime, companies that were designated as long-term losers have become grossly undervalued. Extremely cheap assets are always entitled to recover some of the lost ground. These energy companies have held back from investing in oil fields, having been vilified for years, thus reducing efficiency of fields. Then, the pandemic drove governments around the world to spray cash among voters, in order to revitalize the economy. A suddenly stronger global economy gave a big boost for fossil fuel demand, to which under-invested fields are not able to respond. Crude oil prices, therefore, have shot up, having confirmed their bottoms by the end of 2020. Up to this point was a typical cyclical turnaround, a pattern that was witnessed before. That was not enough, as it turned out. Vladimir Putin’s Russia invaded the neighboring Ukraine. Western democracies’ economic sanctions in response to the invasion has disrupted the oil market. Crude oil prices are soaring amid increasing uncertainty of the global economy. As a result, the Energy sector is on a tear, being the sole performer in the dismal equity market so far into 2022, leaving the rest of the market totally behind. Technology and tech-enabled companies with high valuations, that have been drivers of ESG performances, are brutalized by sharply higher long-term interest rates. This is a perfect storm against ESG investing. While Norway’s sovereign wealth fund has been a leading advocate of ESG investing, some in Norway are reportedly feeling uncomfortable. Rising crude oil prices, caused by Putin’s invasion into Ukraine, are making the country richer as Europe’s leading oil producer while its SWF has been bashing fossil fuel-related investments for years. They never gave a thought on how Norway has become so wealthy. Along with fossil fuel producers, another sub-sector that are bucking the trend to rise in 2022 is defense contractors. This group of companies has been loathed by ESG authorities for profiting from war. Since the breakout of hostilities in Ukraine, however, the industry is beginning to receive some favorable perceptions as contributors to enhanced security, and keeping peace. The real world is not as simple as pictures initially drawn by idealists in Europe. If a war offends the core value of ESG investing, siding with the aggressor can’t be tolerated, regardless of the industry. Of course, few sane investors would choose to stay invested in Russia, especially at a time when Western multi-national corporations have pulled out of the country in droves. Economic prospects in Russia have deteriorated sharply, too. Investment benchmark providers such as Morgan Stanley Capital International (MSCI) and the Financial Times have quickly ejected Russia from their indices, to make life easier for asset managers. Taking a step further, what about Putin’s conspirators? To be specific, this applies to Xi Jinping and the People’s Republic of China, even if they are not a co-aggressor in the Ukraine war. While sitting on the fence, China has not condemned Russia and is importing Russian crude oil, and the Chinese Communist Party’s mouth piece keeps broadcasting Russia’s narrative on the war. Nonetheless, the Western investment community and financial industries have not gone so far as to pull out of China. Long before Ukraine, China could have qualified the ESG ban list. It is not because of the amount of carbons that the country emits but because of alleged human rights breach on minorities, especially in Xinjiang. Decades ago, the global investment community acted fiercely against the apartheid regime in South Africa, devising a benchmark index that prohibited investing in Western corporations with substantial operations and/ or investments in South Africa. Quite a few multinational giants got caught on the list, especially in consumer goods area including car and electronics makers. South Africa-free investing might not have been the prime factor that affected the fate of the apartheid regime, but the white rule was brought to an end in the early 1990s. On top of human rights violations, China has proven to be a corporate governance disaster. It’s been known that state-owned enterprises are not run for shareholders but for the Communist Party. A widely accepted strategy in investing in China was avoiding SOEs and focusing on truly private corporations, especially those in the tech sector, it was believed until 18 months ago. Then the CCP’s assault on the dazzling tech sector began in November 2020, and still sees no end to it. Assault on Jack Ma and Alibaba was considered as an isolated case at the outset, but it quickly spread to the entire tech sector, obliterating the online education space in the process. Hundreds of billions of dollars in value was crushed. The CCP is so determined to bring up-and-coming tech entrepreneurs to heel that they scantly care about unprecedented value destruction. While few could argue with the goal of ‘common prosperity’, this is nothing but a corporate governance nightmare. In the face of all these damages done to the market, the CCP is strangely concerned with capital outflows and wants a greater weight for China in the emerging market benchmark indices. They still don’t get it. They appear to think they can bend everything to the will of the mighty Communist Party. Such a hard-nose stance is exactly what the financial markets abhor. ESG investing is good intentioned, trying to make the world a better place to live. It would achieve its initial objective of superior investment returns over the course of many, many years. Nonetheless, the real world is a great deal more complex than high-minded do-gooders’ simplistic imaginations. Achieving its objective takes in-depth re-examination of what it really wants to achieve, beyond superficial observations, and steering clear of double-standards in the process.


About the author: Mr. Suzuki is a retired banking executive based in Tokyo, Japan.