Many of us have heard of the acronym "ESG," which commonly stands for "environmental, social, and governance." It is becoming more popular on Wall Street for financial products to be described as ESG, or for companies to bolster their "ESG" efforts in order to score better and raise stock prices. But ESG is a broad and capacious term. In too many instances, traditional Wall Street firms have used it as a way to advertise or package existing financial products, without actually moving the needle on environmental goals.
Too many ESG funds say they are trying to change the world, but then fail to live up to their own promises. The Financial Times reported that up to one-third of climate themed exchange traded funds (ETFs) held oil and gas stocks. Another example is the Vegan ETF, a fund that seeks to avoid animal cruelty. Largely composed of high growth tech companies, it ignores (or must work around) the fact that companies like Google have long offered animal products in their in-house cafeterias. At best, many of these funds are imperfect, in that they do not strictly "screen" out companies antithetical to their stated values. At worst, many of these funds are a brazen attempt to greenwash traditional financial products.
Many asset managers, even ESG fund managers, are not using their influence productively. Indeed, according to some research, this problem is endemic across Wall Street. Fund managers like BlackRock, Vanguard, and State Street have enormous clout, owning 82% to 88% of the S&P 500’s market capitalization. They do not often vote in annual shareholder meetings, because they have lent the shares of their ETFs to short sellers. And when they retain their shares and cast their votes, they use their clout to side with management—up to a staggering 93% of the time.
Even when everything goes right, ESG funds that screen out "bad companies" from their portfolios may not move the needle, and can even be counterproductive.
First, ESG funds that successfully screen out "bad" companies—however bad is defined—necessarily lose the ability to influence those companies. Walking away means no ability to vote out recalcitrant board members or introduce resolutions aimed at improving the company from within.
Second, as in physics, for every action there is an opposite and equal reaction. When ESG funds avoid buying shares of polluting companies like coal mines or oil refiners, those companies' share prices may drop, but their valuations also become more attractive. As a result, other buyers step into the void. Bloomberg reported in January 2022, for example, that private equity firms have lined up to scoop up shares of coal mines that have low share prices, in part because they have been shunned by ESG funds. This phenomenon raises a question of strategy: if the result of all this ESG investing is just to swap the ownership of "bad" or pollutive companies from one fund manager to another, is the result any different? Has anything actually changed?
Third, as investments in "good" companies increase, the returns that investors can expect from those companies necessarily fall, all else equal. As the Wall Street Journal explained:
“Take one of the most important rules of investing: The starting price matters. This is clear in bonds, as the price you pay going in determines the yield. In stocks, it should be obvious, but is often ignored. The stock of a hopeless business with only a few years of life left in it could be a great investment, so long as it is even cheaper than the fundamentals justify. Equally, a wonderful, rapidly growing company with a rock-solid business model will be a terrible investment at the wrong price.”
Investors that stick to a strategy of avoidance may pay a price—not just in terms of higher fees from marked-up ESG funds, but also from lower overall returns in the long run.
Firn's approach addresses each of these critiques of greenwashing and ESG investing more broadly. Firn’s ecoFunds allow anyone to directly invest into clean energy assets, like solar, wind, and storage. Additionally, Firn plans to launch a line of exchange traded index funds called Activist ETFs. Activist ETFs will passively invest in a broad index of U.S. companies, keeping the good with the bad. That investment approach will allow investors to earn "market returns," like many traditional index funds. But it also enables the use of shareholder voting (and Firn's deep bench of policy-making expertise) to introduce shareholder resolutions that will make the largest companies better from within, while voting for board members who support those priorities. Each fund will have its own unique sustainability objectives, so people can "vote with their dollar" and invest in the priority or priorities that matter to them. Whether that's mitigating climate change, conserving water resources, or ensuring gender parity, anyone can put their voice in the corporate boardroom.