Antisocial

Jared Dillian
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June 3, 2021
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Comments

We got this news out of the CFA Institute recently:

CFA Institute, the global association of investment professionals, announces today that it will market the Certificate in ESG Investing, created by CFA Society of the United Kingdom[1], in financial hubs across the globe. The education program represents a new global qualification for ESG in investment management; it aims to strengthen market integrity by delivering the benchmark knowledge and skills required by investment professionals to integrate environmental, social and governance (ESG) factors into the investment process.

The Certificate is a self-study course requiring approximately 130 hours of study, culminating in a two-hour, 20-minute computer-based exam comprising 100 questions at a proctored testing center or via online proctored testing, where available and/or permissible by local regulation. Candidates have one year to sit the exam after registration, and there are no formal entry requirements. On successful completion of the exam, candidates will be awarded a certificate. The cost, which covers the exam and online learning, is $665[2] and candidates can claim 20 CE credits upon passing the exam.

For background, I have always been scornful of the CFA designation. You’re not really learning finance—you’re learning how to pass a test. Thousands of hours a year for three (or more) years when I could be riding a skateboard or doing virtually anything else.

Really, it’s an ROI calculation. You have to do the math on what this designation is going to help you achieve versus the time you put into it. There are better ways to use your time.

Anyway, back to ESG—or environmental, social, and corporate governance—investing.

It’s interesting that the CFA Institute is spending so much time on ESG and so little on other things that could actually help you become a better investor, like the dark arts and voodoo of sentiment.

I have never seen an empirical analysis showing that investors with CFAs outperform the ones without. In fact, the opposite may be true.

And now, they’re teaching people to pile into overvalued assets at the expense of undervalued assets.

Waaaah

I should stop complaining about ESG investing. It has created gigantic opportunities to investors of all kinds.

You can’t possibly expect a manager with constraints to outperform a manager without constraints. And the constrained stocks—the stocks that the ESG manager cannot buy—must offer higher returns to induce the unconstrained investors to buy them, typically in the form of a lower starting price.

The types of stocks that ESG investors have been avoiding have had a tremendous rally in the last 12 months. The types of stocks that ESG investors favor have stalled out.

A naïve strategy would be to simply buy all the stocks that the ESG investors exclude. I believe that would produce returns that would exceed the benchmarks over some reasonable length of time.

I’d like to say that ESG is simply a passing fad, but it’s hard to tell. It is getting bigger, and now has the CFA Institute’s blessing. I assure you that people will be less enamored with ESG investing when it begins to sharply underperform.

It is easy to have values when they align with profits. One day, those values may become expensive, and I think people are more pragmatic than you think.

ESG investing has had a profound effect on the financial activities of energy companies. By driving down equity prices and raising bond yields, ESG investors have sharply raised the cost of capital for these firms, making it difficult for them to operate.

The good news? This is being done by the private sector and is a reflection of market discipline, rather than by some top-down ukase by the federal government, although that may be coming soon.

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The energy companies that survive will be well-positioned to take advantage of a bull market.

Not Really Good

Then there is the idea that the sorts of things that the ESG people are measuring are not really a reflection of which companies are good and bad.

Facebook (FB) is a high-rated ESG company but arguably produces more misery and social unrest than all the energy companies combined.

Ditto for all social media companies generally. Nobody talks about the climate impact of Amazon (AMZN) Web Services, but it is substantial.

Natural gas gets a crappy ESG rating too, but it is a lot better than coal. And so on.

And the ESG ratings services can’t seem to agree on what constitutes a socially responsible company—their ratings are all over the place.

ESG may seem new, but it’s been around for a while. The first-ever ESG ETF—the iShares MSCI KLD 400 Social ETF (DSI)—was launched in the mid-2000s. The performance was terrible, and it never attracted any assets.

Back then, we didn’t call it ESG, we simply called it “socially responsible investing.”

In the beginning of this piece, I said that a naïve strategy of simply buying the stuff that ESG managers exclude should outperform the index. That is more or less what I am doing, personally. Not because I am some kind of cartoonishly evil Darth Vader character—it’s just math.

Sure, fossil fuels may disappear one day—in 100 years. Then we will have our George Jetson electric flying cars. It takes a while.

I bought a 19-mpg Corvette, not a Tesla (TSLA). And I am confident about only one of those two appreciating. (Listen to my latest podcast, "Buy Your Next Car Without Getting Too Screwed" if you have any doubts about which one.)