I first heard about the movement of building a portfolio that is aligned with your values six or seven years ago.  I thought it was going to be a fad because it made no sense to me.  Boy was I wrong.  Last year there was approximately $380 billion dollars invested in ESG.  These funds focus on allocating capital towards companies that the fund manager believes are favorable toward Environment, Social, and Governance.  In today’s post, I will explain why I don’t think it matters in public securities.  I will follow that up with a section on exploring what each letter in an ESG score means.

It Doesn’t Matter

There are dozens of companies that I consider sleazy and I wish their products would be banned, their executives would face jail time, or that they would file bankruptcy.  Through diversified exchange traded funds, I am a very small partial owner of these companies that I despise.  I don’t lose sleep over it and I have no guilt of owning these stocks because I know that I am not helping these firms by buying and holding their stocks.  I will concede that I am benefiting from them as their stocks rise and I am receiving some of their profits returned to me via stock buybacks and dividends.

Stock prices are set on the margin because the vast majority of shares outstanding are not traded daily.  Me holding a stock in my index fund that is in the defense, coal, or tobacco business does not help the company.  It does matter if the company needs to issue more shares of stock and I buy shares FROM the company.  This would raise new capital for the company I don’t like.  It also benefits the company if I invest in them privately to give them funds to grow their business.  Lastly, it helps them if I am part of a new loan or new bond offering.  Here I am giving them new money.  Owning small amounts of their stock doesn’t benefit the company.

If I want to punish the sleazy company and actually make a difference, I can choose to not purchase their products, start a class action lawsuit (if there is reason), write a book against their business practices, encourage others to not do business with them, etc.  Imagine if a large amount of the population really hated ABC bank for the baby seals they murder.  If enough of us went into every store we visit and asked the owner if they banked with ABC and then told them we would no longer shop in their stores until they cut ties with ABC; ABC Bank could go out of business or at least stop being so evil.  A real world example of this kind of community action happened to the Richards Group in 2020.  Their founder resigned and they lost a lot of business after he said said some offensive comments in a meeting.  Today, consumers are actively boycotting Balenciaga and InBev, the owner of Anheuser Busch.

My last reason I don’t think public investments into ESG matters can be illustrated below.  Here are the top 10 holdings of SPY (SPDR S&P 500 Index) and ESGU (the largest ESG mandated ETF).  The top ten holdings in the first fund make up 26 cents of every dollar you invest and 27 cents of every dollar in the second fund.  Can you guess which fund is changing the world with the magic of ESG and which fund is the plain old S&P 500?

 

Both funds are loaded with mega Tech.  The first fund doesn’t own Berkshire Hathaway, but has Coca Cola and Exxon Mobile in it’s top ten holdings.  Exxon is the 11th largest position and Coca Cola is the 24th largest position of the second fund.  It turns out that the first fund is ESGU-the ESG fund and the second fund is SPY.  Barely a difference.  Until I started writing this, I had no idea Buffet’s Berkshire wasn’t ESG and not in the top 30 holdings of ESGU.  I am not even sure why.  It can’t be because he is a big shareholder of Apple and Coca Cola.  Perhaps the masters of ESG decided to ban Buffet for investing in big oil (Occidental Petroleum) or big trains (Burlington Northern Santa Fe).  Perhaps it Warren’s position in Wells Fargo who got caught in fraudulent sales practices and through Wachovia was helping El Chapo Guzman launder the money he got from human trafficking, drug sales, and extortion.  I honestly don’t want to waste my energy to find out.  Why is that nasty CO2 producing Exxon is a higher weight in the ESG fund than the S&P index?

There are lots of ESG ETFs and mutual funds you can invest in.  To keep this post relatively short, I will be focusing on ESGU because it has the most assets.

Environmental

My biggest problem with ESG investing is the E.  The world is not black and white and can’t be boiled down to oil is evil and electric cars and appliances are the only solution.  Everything is a trade off and we have to recognize that if the world didn’t have oil and smart people didn’t invent engines and ways to extract that oil, most of us would not have been born and those who are here may be burning whale oil for their light, riding a stinky horse to work, and cutting down trees to stay warm.  Fossil fuels have dramatically improved our lives and this must be recognized.  I can fill up my SUV for about $35 and it goes about 320 miles on its tank.  Can you imagine how much human energy it would take for me to physically push it back with its contents for 320 miles?  Energy is life and there is no such thing as prosperity without it.  If the politicians that are pushing for net zero were honest, they would admit that the only way we can decarbonize our economy to reach their goal is to use way MORE fossil fuels.

Look how much copper is used in green energy cables!

You might need one of these to mine all that copper for your green energy.

Here is where a lot of children go to work everyday to mine cobalt.  Should these mines be included in ESG because without them there is no net zero?

Here is a neodymium mine.  Far too many people see the windmills and not where the blades go into the landfill after 20-30 years, the amount of energy and materials mined, or the 150 murdered bald eagles.

Take a look at this video from MidAmerican Energy.  Notice how much diesel gets burned to transport the parts, clear the foundation.  That is a lot of steel and concrete for the base.  Where did it come from?  If we “just stop oil,” how we lubricate the gears on these windmills?

To make my point that all companies do some good and bad and ESG is subjective, I am going to pick on two of the top 10 holdings of ESGU, Nvidia and Amazon.  Nvidia is one of the top performing stocks of the last 10 years and early investors have made fortunes on their excellent graphics processing units (GPUs).  Nvidia doesn’t make the GPUs, but they do contract the work out and chips use a ton of energy to make.  These chips then run in gas burning cars, gaming computers, and Bitcoin mining equipment.  It is reported that Bitcoin mining uses more electricity per year than the entire country of Argentina!  If I really want to nitpick, I can make the case that a company that enables the Bitcoin network to waste so much electricity should be kicked out of all ESG mandated funds.

Who doesn’t love Amazon?  It saves my wife and I dozens of hours a year by delivering hard to find and obscure items to our house.  It also runs a lot of the websites that we use through Amazon Web Services.  I don’t have a magic ESG carbon sniffer, but Amazon has to use more carbon than almost any company in the world.  If you count all the plastic items made from oil and all the products that are made in Asia and shipped to Europe and the U.S., we are talking about a lot of fossil fuels.  Once these items arrive to their country some are flown around and some are driven in trucks and then eventually driven to your home.  How many forests are cut down from all the boxes and how much electricity do the server farms use per year?  If I want to look at just the negatives, could I not find a way to eliminate Amazon from ESG funds?

The following two resources have shaped my beliefs:

The Inadequacy of Wind Power by Wade Allison

and the below video.  At the 28 minute, Mark talks about a calculation done by Volkswagen using the European electric grid and a small battery in an electric car.  He states that when you count the extra metal and energy used to mine and manufacture the electric car, it doesn’t break even with a gas powered car until 60,000 miles and is only 20% lower carbon emissions at 120,000 miles!  I would love to see a calculation at 200,000 miles using a full sized battery on China’s grid where you may have replaced that battery twice.

When it comes to green or renewable energy or the transition to lower carbon economies, you can’t just say Tesla good and Shell bad.  The world is not that simple.  Let me leave you with the concept of Energy Return on Investment EROI from Goehring & Rozencwajg’s fourth quarter 2022 Commentary.  EROI means how much energy was returned based on the energy invested.  They state:

An efficient natural gas plant achieves an EROI of 30:1 after accounting for the energy needed to drill, lay pipelines, build the plant, and burn the gas. On the other hand, a top-performing onshore wind turbine is lucky to achieve an EROI of 12:1, while high-quality solar’s EROI is 8:1. These figures are on an “unbuffered” basis, meaning they do not adjust for renewable power’s intermittency. Utilities must install massive battery backups if they use wind and solar for base-load power. These batteries are very energy intensive to manufacture, lowering the buffered EROI to 6:1 and 2:1 for wind and solar, respectively. Therefore, it requires between 4 and 14 times more energy to generate a kwh of electricity on a buffered basis with renewables than with natural gas…A viable solution exists today in the form of nuclear fission. Generation IV nuclear plants offer EROIs over 180:1 – far superior to renewables and traditional energy.

I hope I have given you a different way to think about the environment, prosperity, and how much more complex our grids, economy, and supply chains are when you do a little digging.

Social

According to Investopedia.com, the S in ESG stands for how a company manages its “relationships with employees, suppliers, customers, and the communities where it operates.”  I find this to be just as fuzzy and hard to define.  A good ESG company is supposed to extend their ESG policies to their suppliers.  Apple is the most valuable publicly traded company in the world and currently work over 2.5 Trillion US Dollars.  They have built a truly great brand.  I don’t have a PhD in ESG, but if I am rating a company on how its suppliers’ employees are treated, it is hard to put Apple on my list.  They installed suicide nets around the Foxconn factory to prevent the iPhone assemblers from taking their lives.  This article says they used to sleep 12 people to a dorm and now it is 8.  The treatment of their peasant labor is so well known that it made it into this Saturday Night Live skit.

Meta, formerly Facebook, is the 11th largest holding in ESGU.  I can’t say I would score the Social Media App high on Social.  If you are supposed to respect your customers and suppliers then the 2018 Cambridge Analytica data scandal would rate it an F.  The This is Your Digital Life app broke Facebook’s terms of service from 2012 to 2018 and collected vast amounts of data on their 270,000 users.  Cambridge Analytica used databases and friend connections to ultimately gather the personal data for 87 million people.  Facebook settled the class action lawsuit for $725 million.

Facebook also paid the Winklevoss twins $20 million dollars and $45 million worth of Facebook stock in 2008 for a settlement over who came up with the idea for Facebook.  Lastly in August of 2022, Mark Zuckerberg told Joe Rogan that they throttled sharing over the Hunter Biden laptop story.  The FBI lied that about the laptop and Facebook potentially altered a U.S. Presidential Election.

We can also look at the awful things in this Tweet Thread that Johnson and Johnson has done for its stakeholders.

JNJ has a market capitalization of over $500 billion and they sold talc powder with asbestos in it that injured 60,000 of their customers.  They could have easily paid the damages, but instead have filed a second bankruptcy via a “Texas Two-step” to avoid paying the lawsuit brought against them.  Using their own definitions of for ESG, I don’t see how the ESG consultants come up with their lists.

Lastly Coke and Pepsi are in the ESG fund.  Sugar water and processed carbohydrates are bad for human health.  Consuming these products can cause weight gain and type 2 diabetes.  How much of our taxes pay for obesity and diabetes treatment through Medicare and Medicaide?

Governance

This is the most wishy-washy of the the three.  From my understanding to get a good score on the G, you need to have a diverse company and board, good financial and accounting controls, and be ethical and legal.  I think far too many companies are making diversity hires and not choosing the best man or woman they can find for the job.  I don’t care what color my pilot or surgeon is.  I want a competent one.  Hiring to check a box will ultimately hurt your company.  Making sure your company isn’t cheating on taxes or committing crimes is just table stakes.

The 30th largest holding in ESGU is Pfizer.  This article is the best source for Pfizer’s numerous violations.  Here are just a few:

2009 Pfizer paid the largest criminal fine in the history of the United States ($2.3 Billion) for misbranding Bextra and paying kickbacks to doctors.

2012 Pfizer pays $1.2 billion for Prempro allegedly causing breast cancer.

2012 Pfizer is charged by the SEC for violating the Foreign Corrupt Practices Act by bribing health care professionals.

2016 Pfizer was fined £84.2 million for over billing the NHS for Phenytoin.

You can give a ten year old the definitions of ESG and then have them read the above link and they would know Pfizer has a low score on the G!  Why is it a holding in so many ESG funds?

Besides seeing Exxon having more of an allocation than it does in the S&P 500, my second biggest surprise was to see that the 33rd largest position in ESGU is Raytheon.  You can’t make this up.  I assume a large amount of investors who want to vote with their values would not want to see arms manufactures in their portfolio.  I am glad so many people are disgusted with the horrors of the war in Ukraine.  I wish more people would read this and see how awful the Houthi civilians have been treated by the Saudis and indirectly the U.S.  Where did a lot of those weapons come from?

In summary, I own stock in every single company in my index funds and it is not helping the companies one bit.  Most of the people at these companies are good, hard-working people that might be friends or clients.  It only takes a few bad apples at the top to make the whole company look bad.  I hope I have shown you how subjective the ESG scores can be and how by using their own logic, we can come up with ways to give a low ESG score to almost any company.  ESG funds have been gathering assets for a decade, but you are starting to see outflows.  ESG funds have very little exposure to the energy and materials sectors.  Some people are predicting that the 2020s will see stagflation like the 1970s.  The Dow Jones just bounced around 1,000 for the entire 1970s.  Oil stocks and Gold miners were the very best places to have your money back then.  If this repeats, I wonder how many investors will stick to ESG if it causes them to massively under-perform the overall markets.