Recently in Washington, Joe Biden exercised his presidential veto powers for the first time on a bill that would have banned federal pension fund managers from considering ESG issues for investment and shareholder rights decisions. The Republicans want to stop what they’re calling ‘woke¹ liberal’ practices by their customary friends in Wall Street and Corporate America.
On the face of it, this looks like just another spat between the two parties over climate change that they can use to differentiate themselves in the lead up to the 2024 presidential election. But underlying it is an attempt to further limit American citizens freedoms from a party that has historically purported to support them.
ESG investing
The significance of the Republican party’s position lies in the difference between ESG investing and ethical investing. ESG investing technically refers to an investment framework that considers the environmental (pollution, climate change, water and other resources scarcity), social (local communities, employees, health and safety) and governance (prudent management, business ethics, strong boards, appropriate executive pay) issues of investing in the belief that doing so decreases investment risk and increases the expected return of the investment. And there is a bucket-load of research to suggest it does. In the same way you might want to consider rising sea levels if you’re buying a coastal property, investment managers can also increase their returns from considering the implications of climate change on the investments they make. When they do this, they are ESG investing.
Ethical investing
In contrast, ethical investing is about the morality of investments. Are companies doing things that are good or bad? Or right or wrong? Philosophers have been debating ethics and morals for centuries and are still unable to come to a unanimous agreement on what is and isn’t. In this context, I don’t think it’s appropriate for investment managers to be making these decisions for investors or humanity. They are personal decisions that vary from person to person. You may think your view on gambling or fast food or nuclear power should be held by everyone. But the reality is, in certain jurisdictions, these are legal products and services, and I believe people should be free to choose if they want to partake in them. And equally free to choose if they want to invest in them.
Direct indexing and managed accounts provide a solution
In our view this is where direct indexing or ethical screens in managed accounts come into their own. We use both:
- Direct Indexes: Start with a passive portfolio of the top “X” stocks
- Managed Accounts: Fund managers pick the stocks they think will outperform
Investors then screen stocks out of their own portfolios:
Importantly, these solutions are not expensive. A direct index, with customisation where you can add themes in that you like (eg. quality stocks, cloud computing, nuclear power etc) and remove themes that you don’t like, starts around 0.35% for a typical sized SMSF. Investors with a few million can see costs closer to 0.2%.
What type of investor are you?
So, whether you consider yourself a sustainable investor, non-sustainable, liberal or conservative, the research suggests there are economic benefits from including ESG in your investment process and ethical investing is not one size fits all. There are tools you can use to account for the grey.
¹ I am not comfortable using the term ‘woke’ as it represents a cultural appropriation from Black Americans who continue to suffer from the effects of racism. But this term has migrated to the mainstream, and is being used in the context of this discussion; as such I felt it was necessary to selectively reference it for this article.
The concept of woke or wokeness comes from the African American ‘idea of Black consciousness “waking up” to a new reality or activist framework’.
