Chronicles: Issue 31, September 2022

What a difference a year makes. Late last year, the industry couldn’t get enough “ESG.” It was a feeding frenzy across LPs, GPs, academics, consultants, and even professional bodies. Large endowments swore off fossil fuels entirely, signatories of various standards proliferated, and leaders of energy companies were castigated. A goldrush of greenwashing and a devastating war in Ukraine have exposed the implications of our cavalier impatience in chasing energy transition. It’s clear that we got over our proverbial skis; our heart led our head, and now we must find a better balance and more deliberate pace that considers second and third derivative implications.

While most of the world watches the political food fights of the US on the issue with a mix of confusion and amusement, there is no doubt that the public square bickering between State governments and the industry has become ground zero of this global journey. And so, we dedicate this month’s issue of Chronicles to exploring and equipping you with the latest from the front line of this evolution.

There is much to say as this plays out in real-time, but we will briefly highlight two issues followed by some suggested reading:

First, we must be precise in identifying roles and responsibilities of the major players and pull back the juvenile partisan rhetoric that has come to dominate most all US debates. Asset owners (specifically public pensions) own a fiduciary responsibility to deliver retirement benefits to their beneficiaries across multiple generations. Any prudent investment professional should consider all material risk and return factors when assessing and recommending individual securities, sectors, and asset classes. That absolutely includes the existential risk of stranded assets on a balance sheet, the risk of regulatory litigation, and the opportunities for ROE accelerators like diversity of leadership.

Asset Managers are hired by the Asset Owner to solve a portion of this fiduciary responsibility by filling a specific role in the overall capital pool. Asset managers should not be inserting values-based judgments in their strategies without transparency and approval from their clients. As such, demonizing managers, who are simply packaging and delivering what clients are asking for, is simply a scapegoat that sheds light on the misunderstanding of the larger issue at hand. Blackrock recently counterpunched against critics on this issue.

Legislators and State Leadership ensure the legal and regulatory framework is in place to allow the market to innovate and compete in a way that optimizes client outcomes. It is naïve to suggest that free markets alone can fix the climate crisis, given their excessive focus on short-term gain. However, politicians should neither be forcing investment professionals to avoid or ban “dirty” sectors nor prohibit considering them by pretending these issues aren’t explicitly monetary and relevant for long term valuation.

Secondly, CAIA warned the market last year in our Institutional Investor editorial that the “ESG” label should be dismantled. It was a case of measuring nothing by attempting to measure everything. Albeit well intentioned, we fear it is the most ardent proponents of the ESG movement that led us right into this mud-slinging trap and now present the biggest headwind to its credibility. Recently, we published a sequel with Barron’s that expresses more urgency to slay the leviathan, that is the ESG acronym, as it has distracted and misdirected our efforts to solution critical ecological, social, and human challenges.

Buckle up.