Bogleheads® on Investing Podcast 046: Larry Swedroe and Ellen Quigley on ESG Investing

00:00:00.000 | (upbeat music)

00:00:02.580 | - Welcome to Google Heads on Investing podcast number 46.

00:00:14.520 | Today we focus on ESG,

00:00:16.520 | Environmental, Social and Governance Investing.

00:00:19.380 | Our two guests are Larry Suedro,

00:00:22.440 | talking about his new book, "Sustainable Investing",

00:00:25.600 | and Dr. Ellen Quigley,

00:00:27.320 | a Senior Research Associate in Climate Risk

00:00:29.800 | and Sustainable Finance,

00:00:31.300 | and also a Special Advisor to the Chief Financial Officer

00:00:34.920 | at the University of Cambridge.

00:00:36.520 | Hi everyone, my name is Rick Ferry

00:00:49.120 | and I'm the host of "Google Heads on Investing".

00:00:51.440 | This episode, as with all episodes,

00:00:53.480 | is brought to you by the John C. Bogle

00:00:55.440 | Center for Financial Literacy,

00:00:57.440 | a 501(c)(3) nonprofit organization

00:01:00.840 | that you can find at boglecenter.net.

00:01:04.280 | Your tax deductible contributions are greatly appreciated.

00:01:07.960 | And don't forget about our Bogle Heads Conference

00:01:10.680 | coming up this October 12th through the 14th

00:01:13.800 | in a suburb of Chicago.

00:01:15.520 | There are a few tickets left

00:01:17.240 | and we would love to see you there.

00:01:19.300 | Our focus today is on ESG investing.

00:01:23.240 | ESG stands for environmental, social, and governance.

00:01:27.600 | It's the hottest thing

00:01:28.920 | in the investment industry right now.

00:01:30.680 | Hundreds of mutual funds and ETFs have been created

00:01:34.160 | clamoring for your dollars,

00:01:36.000 | enticing you to invest with your conscience

00:01:39.320 | in addition to with your money.

00:01:41.840 | But is this really a strategy to take seriously?

00:01:46.260 | Does it actually achieve the goal of environmentally friendly,

00:01:51.080 | socially responsible, and better governance

00:01:54.260 | in how corporations behave and make decisions?

00:01:57.640 | Or is ESG a scam, as Elon Musk said recently?

00:02:02.640 | That's my discussion today with two special guests,

00:02:06.600 | Larry Swedrow, chief research officer

00:02:09.440 | for Buckingham Strategic Wealth

00:02:11.480 | and the co-author of a new book called "Sustainable Investing"

00:02:14.800 | and Dr. Ellen Quigley, who is a senior research associate

00:02:19.040 | in climate risk and sustainable finance

00:02:22.000 | at the Center for the Study of Existential Risk

00:02:25.280 | and also a special advisor to the chief financial officer

00:02:29.600 | at the University of Cambridge.

00:02:31.920 | I promise you this will be an interesting podcast.

00:02:36.000 | First up is Larry Swedrow.

00:02:38.400 | With no further ado, let me introduce Larry Swedrow.

00:02:44.600 | Welcome again to the Bogleheads on Investing podcast, Larry.

00:02:48.200 | - Good to be back with you, Rick.

00:02:50.400 | - Larry, your latest book with Samuel Adams

00:02:53.320 | is titled "Your Sensible Guide to Sustainable Investing,

00:02:57.900 | "How to Live Your Lives and Achieve Your Financial Goals

00:03:00.680 | "with ESG, SRI, and Impact Investing."

00:03:05.680 | But before we begin, I just wanna remind people

00:03:08.920 | of who you are.

00:03:10.640 | You're the chief research officer

00:03:12.200 | for Buckingham Strategic Wealth

00:03:14.480 | and has published 10 books and has co-authored seven books,

00:03:19.480 | and this is the seventh.

00:03:21.540 | Now, your co-author is Samuel Adams.

00:03:24.840 | Could you tell us how you met Sam

00:03:26.520 | and why you decided to write this book together?

00:03:29.120 | - Yeah, I actually met Sam probably about 25 years ago now

00:03:33.480 | where he was our regional director at Dimensional,

00:03:38.080 | so I got to know him there and enjoyed working with him.

00:03:42.360 | And then I'd followed his career.

00:03:44.440 | He had moved to England to help start a DFA business there

00:03:49.400 | or grow it, and then he left to follow his passion.

00:03:52.840 | He created a, I think, the first

00:03:55.360 | and maybe still only sustainable real estate fund

00:03:58.920 | called VRT.

00:04:00.320 | A reason I contacted and reached out to Sam

00:04:03.440 | to write the book is I noticed

00:04:05.040 | there was a dramatic increase, beginning really in 2018,

00:04:09.600 | in investor interest in ESG investing

00:04:12.880 | with massive amounts of cash flows.

00:04:15.360 | And as usual, academic research tends to follow

00:04:18.320 | whatever is the hot subject,

00:04:20.160 | and dozens and dozens of papers were being written,

00:04:23.760 | and I would write them up

00:04:25.120 | so I could convey what the research was finding.

00:04:30.120 | And then I said, "Well, it'd be great if we had a book

00:04:32.520 | "to discuss these issues and show people

00:04:35.360 | "what the real evidence from empirical research showed

00:04:38.980 | "as well as the theory behind it

00:04:41.960 | "so you could make a good informed decision

00:04:44.360 | "about whether you wanted to be an ESG investor or not."

00:04:48.120 | So I had the knowledge and skills to write the part

00:04:52.440 | on the empirical research, the economic theory,

00:04:55.760 | and the impact of behavior on corporations.

00:05:00.000 | And Sam had all of this knowledge

00:05:02.600 | as a nationally known speaker in the field

00:05:05.000 | about the whole history of the SRI, ESG,

00:05:09.380 | impact investing movement.

00:05:11.380 | So I reached out to him and suggested we join forces,

00:05:15.160 | and he wrote, in effect, the first half of the book

00:05:17.780 | with my help, and then he helped me complete the second half.

00:05:21.420 | So it was a good fit for Sam,

00:05:23.700 | and I enjoyed working with him very much.

00:05:26.340 | - Yeah, and that did come out, by the way,

00:05:27.620 | when I was reading the book, it seemed to me clear

00:05:30.240 | that Sam had wrote the beginning,

00:05:31.860 | and you wrote the research portion in the middle.

00:05:34.580 | And then, at the end, you probably collaborated together

00:05:37.240 | on the how to do it portion,

00:05:39.780 | which is how the book is really divided

00:05:41.260 | into three different sections that way.

00:05:43.700 | In fact, the first section, which defines ESG investing

00:05:47.900 | and the evolution, if you will, of ESG investing,

00:05:52.020 | and I just want to point to the title of your book,

00:05:55.540 | the whole title, because in it,

00:05:58.580 | it kind of talks about one of the issues.

00:06:02.180 | Your title of your book is Sustainable Investing,

00:06:06.780 | How to Live Your Values and Achieve Your Financial Goals

00:06:11.020 | with ESG, SRI, and Impact Investing.

00:06:16.020 | So in the title of your book,

00:06:19.180 | you have four different strategies, I assume,

00:06:23.560 | and it's all very confusing.

00:06:25.100 | So if you could start with

00:06:27.480 | how did this whole evolution begin,

00:06:30.940 | and what all these terms mean.

00:06:34.100 | - It's really a great question.

00:06:35.380 | We struggled with how to title the book,

00:06:38.140 | 'cause ESG is probably the most familiar term,

00:06:41.540 | maybe SRI before that.

00:06:44.320 | But I think Sam did a great job

00:06:47.020 | in writing the history of the movement.

00:06:49.320 | I'll see if I can summarize it briefly.

00:06:51.900 | So the original thinking was negative

00:06:54.300 | or exclusionary screening to screen out values

00:06:58.980 | that you wanted to express.

00:07:00.660 | So you might think of the Quakers' Civil War,

00:07:05.580 | screening out any company engaged in the slave trade,

00:07:09.860 | eventually became sort of a holy trinity,

00:07:13.820 | if you will, of sin industries,

00:07:15.620 | tobacco, alcohol, and gambling.

00:07:18.980 | You might add pornography, it would be another.

00:07:21.680 | Some people add defense industries.

00:07:25.040 | And that focused on your personal values.

00:07:29.380 | So that's an important distinction here.

00:07:32.700 | Then we got a movement towards ESG,

00:07:36.960 | which focuses on the companies and their behavior

00:07:41.140 | in the areas of climate change or environment,

00:07:44.980 | social and diversity and governance.

00:07:48.420 | And then the last part became impact investing,

00:07:52.560 | which is really a desire to make change in the world

00:07:58.300 | and not focusing on the return mostly.

00:08:01.180 | So Rick Ferry decides he wants to help the people in Africa

00:08:05.260 | and he's gonna invest in a company

00:08:07.540 | that helps build water wells so they can get clean water.

00:08:11.820 | And he thinks that's a much better way to do it

00:08:14.580 | than giving money to some government

00:08:16.540 | because he knows the history is,

00:08:18.500 | often that ends up lining the pockets of politicians

00:08:22.180 | and it's not sustainable.

00:08:24.620 | So if you do it through businesses

00:08:26.980 | that continue to ongoing,

00:08:28.740 | it tends to be more sustainable from that aspect.

00:08:33.020 | So the purpose of it is,

00:08:35.220 | hey, I really wanna help the world.

00:08:36.700 | If I get a good return, that's great.

00:08:39.260 | But if not, that's also okay.

00:08:41.800 | So that's sort of the three ways break it down.

00:08:44.700 | One screen out, that's negative screening, that's the SRI.

00:08:49.220 | ESG focuses on the corporate behavior,

00:08:52.320 | but you still wanna achieve your financial goals.

00:08:55.900 | And impact investing is sort of almost

00:08:59.140 | to the edge of pure philanthropy

00:09:01.980 | where it's just the financial end

00:09:04.340 | is a secondary consideration.

00:09:06.820 | And sustainable investing encompasses all of it.

00:09:10.180 | - Basically you're putting under the umbrella

00:09:12.420 | of sustainable investing, you're putting ESG,

00:09:16.120 | well SRI, which has to do with screening,

00:09:18.660 | ESG, which has to do with changing company behavior,

00:09:21.860 | and impact investing, which has more to do with philanthropy

00:09:25.040 | and you're putting it all under sustainable investing.

00:09:28.560 | - Impact investing is just closer to philanthropy.

00:09:30.820 | There's still a financial incentive

00:09:33.180 | 'cause you're hoping to get a return,

00:09:35.140 | but that's not the main objective.

00:09:37.380 | - Okay, and then there are other things too.

00:09:39.420 | And I just wanna go through this laundry list of names.

00:09:42.340 | Green investing, responsible investing,

00:09:46.540 | value-based investing, ethical investing,

00:09:50.100 | purposeful investing.

00:09:51.640 | I mean, is this all just one sub-level

00:09:55.220 | of one of these other ones?

00:09:56.940 | - Yeah, green just infers to companies

00:10:00.020 | that have say good scores from an ESG perspective.

00:10:04.620 | Then you have on the flip side of green

00:10:06.660 | or brown or sin stocks.

00:10:08.980 | Values-driven is really SRI, a type of investing

00:10:13.260 | where you're often screening out companies.

00:10:16.080 | So it's all under the same umbrella.

00:10:17.980 | And that's why we chose to use that term

00:10:20.640 | sustainable investing as a broad category

00:10:23.600 | covering all of them.

00:10:25.360 | - Okay, that's the first part of the book

00:10:27.920 | that covers the first six chapters,

00:10:30.020 | which covers breaking out and defining

00:10:32.880 | what all of these different aspects

00:10:35.400 | of sustainable investing are.

00:10:38.120 | The second part of the book,

00:10:39.440 | basically the part that you wrote with Sam's help

00:10:42.120 | had to do with returns and the impact

00:10:46.720 | that doing this actually has on society or on companies.

00:10:51.440 | And with that, I wanna go to the introduction

00:10:56.440 | because the introduction was written by Burton Malkiel,

00:11:00.600 | of course, a famous Princeton professor

00:11:03.480 | who wrote "A Random Walk Down Wall Street."

00:11:05.640 | And when I was reading the introduction,

00:11:10.000 | and then I read the book, I had to scratch my head.

00:11:12.520 | Let me just give you the five things

00:11:14.620 | that Malkiel said right in the introduction.

00:11:17.000 | And so number one, he said,

00:11:19.440 | talking about ESG objectives,

00:11:23.600 | the term means different things to different people

00:11:26.280 | and it is difficult for investors to understand exactly

00:11:30.120 | what the ESG portfolios actually achieve.

00:11:33.800 | That's number one.

00:11:35.200 | Number two, ESG ratings, what you alluded to,

00:11:38.920 | ratings of companies, differ remarkably

00:11:42.160 | from one provider to another.

00:11:45.860 | He gave an example of Carbon Footprints

00:11:47.880 | where one company would be rated high

00:11:50.540 | and another ESG rating service would be rated low.

00:11:52.740 | So there's a lot of discrepancy between these ESG ratings.

00:11:57.140 | But number three, he mentioned return.

00:12:01.700 | And he said, "Investors who wish to invest sustainably

00:12:05.860 | "should have reasonable expectations,

00:12:08.000 | "including a willingness to accept lower,

00:12:11.460 | "long run returns."

00:12:12.540 | So that was number three.

00:12:13.700 | And number four, this is talking about the ESG portion

00:12:17.140 | of affecting company's behavior.

00:12:19.920 | There is no clear evidence, however,

00:12:22.480 | that disinvestment from unsustainable firms

00:12:26.780 | has interfered with their ability to raise capital.

00:12:29.020 | So those firms that are excluded,

00:12:31.280 | there's no evidence that it had any effect on them,

00:12:34.060 | financially.

00:12:34.900 | And finally, he's talking about the funds

00:12:37.540 | and the way that you would invest in ESG.

00:12:39.580 | He said, "Funds are less diversified and more expensive

00:12:44.100 | "than pure index funds and may well underperform

00:12:47.540 | "in the long run."

00:12:48.820 | So I'm reading this introduction, I'm saying,

00:12:51.460 | I mean, I give you a lot of credit for publishing it,

00:12:54.180 | but what are your comments on all that?

00:12:57.380 | - Well, that's why we wrote the book,

00:12:59.780 | is to address every one of those issues.

00:13:03.100 | Amal is right in raising these questions, Rick.

00:13:06.900 | So why don't we take each one of them one at a time,

00:13:11.900 | pick the first one,

00:13:13.020 | and then we'll go through each of those five,

00:13:15.660 | and we'll try to answer them quickly.

00:13:18.340 | - Okay.

00:13:19.180 | The first one is why would anybody even wanna do this?

00:13:21.340 | I mean, what is the purpose?

00:13:22.940 | - The first answer to that is a lot of people

00:13:26.500 | want to express their values through their investing.

00:13:29.980 | They don't wanna support industries

00:13:32.020 | that their belief system doesn't agree with.

00:13:35.100 | So whether it's gambling or abortion

00:13:38.700 | or companies I don't wanna support

00:13:41.540 | who don't treat women or minorities fairly,

00:13:44.460 | they will want to say,

00:13:45.900 | "I'm not gonna invest in those companies."

00:13:49.540 | Companies that pollute the planet

00:13:51.860 | aren't investing in sustainable investing and renewables.

00:13:55.820 | So that's the main purpose.

00:13:57.620 | Many people at least think about

00:14:00.060 | why we wanna do sustainable investing, ESG or SRI.

00:14:05.700 | - Thank you for that.

00:14:06.540 | Let me go on to the second one.

00:14:07.940 | Talking about ESG ratings.

00:14:09.620 | Now, first of all, describe companies that do ESG ratings

00:14:13.540 | and what are they trying to achieve

00:14:15.340 | and why are they vastly different

00:14:17.180 | when you look at the ratings of one provider

00:14:20.340 | looking at one company

00:14:21.940 | and another provider looking at the same company?

00:14:25.180 | - Yeah.

00:14:26.020 | So here we have a little bit of bad news for investors.

00:14:29.420 | It's not like in the corporate bond market.

00:14:31.700 | As you know, Rick,

00:14:32.660 | we have Fitch, Moody's and S&P.

00:14:35.020 | And if you look at Fitch's rating for a company,

00:14:37.900 | if it's BBB, the odds are almost 100%.

00:14:41.620 | The other two ratings will also be BBB.

00:14:44.780 | We have a huge disparity in the ratings

00:14:48.180 | among seven companies.

00:14:49.980 | The major ones include MSCI, Morningstar,

00:14:53.300 | Sustain Analytics and a couple of others.

00:14:56.580 | So seven big players in the industry.

00:14:59.140 | And it's very easy to point out why there can be differences.

00:15:03.260 | Just think about, for example,

00:15:04.740 | you have the three categories of ESG

00:15:07.740 | that everyone looks at now.

00:15:10.540 | But Rick Ferry as a rater decides to give a one third rating

00:15:14.820 | or equal importance to each of those.

00:15:17.420 | But another rater gives 70% to climate,

00:15:21.060 | 20% to the S and 10% to the G.

00:15:24.980 | So you're gonna get very different answers.

00:15:27.380 | And Rick Ferry decides when he looks at the social question,

00:15:31.980 | he's gonna look at how many women and minorities

00:15:35.180 | on the board.

00:15:36.260 | And another firm will look at the number of managers

00:15:39.580 | who are women and minorities.

00:15:41.300 | And a third will decide to look at pay gaps.

00:15:45.020 | And if they look at all three,

00:15:46.460 | they may weight them differently.

00:15:48.580 | On climate, you get some really interesting questions

00:15:52.900 | 'cause there's not a mandatory requirement

00:15:56.580 | that the SEC has about what you have to report.

00:16:00.140 | So there's something, a breakdown that is called scope one,

00:16:04.060 | scope two, and scope three emissions.

00:16:07.140 | Most companies only report what is called scope two.

00:16:11.500 | Those are the emissions you create by making your product.

00:16:16.460 | Scope one is all the inputs that you get

00:16:19.500 | when you get the materials and stuff to then make.

00:16:23.140 | And scope three includes the product

00:16:26.340 | when it gets delivered to Rick Ferry, the consumer.

00:16:29.820 | So you might think, and I'm just making this up,

00:16:32.300 | but someone could look at Amazon and say,

00:16:34.980 | it's a great company.

00:16:36.420 | All its electricity is created by solar electricity,

00:16:41.420 | other renewables, they don't produce anything.

00:16:44.860 | So there's not a pollution there.

00:16:46.940 | But then if you look at scope three,

00:16:49.260 | and again, I'm making this up,

00:16:50.820 | they have all these thousands, if not tens of thousands

00:16:54.060 | of trucks driving around polluting the air.

00:16:56.660 | So if you look at scope three,

00:16:58.340 | which most companies don't even report on,

00:17:02.060 | you could come up with a very different answer.

00:17:04.740 | And we show in the book, very wide dispersions.

00:17:08.020 | - The company that comes to mind

00:17:10.700 | on this issue is Tesla, right?

00:17:13.700 | So a Tesla car, you've got to import all of this stuff

00:17:20.300 | and it's a lot of plastic, right?

00:17:22.420 | And which is petroleum.

00:17:23.900 | And so what is the carbon signature of producing the pieces

00:17:29.780 | that go to the Tesla manufacturing plant,

00:17:33.660 | which then gets assembled, and that's a cost too,

00:17:37.020 | but they have a lot of solar panels on the roof.

00:17:38.940 | So maybe it's not that much of a carbon footprint.

00:17:43.220 | And then the cars go out there and are sold

00:17:46.260 | and there is a carbon footprint

00:17:49.100 | to producing the electricity.

00:17:51.300 | So in your framework of one, two, three,

00:17:53.220 | could you look at Tesla?

00:17:55.500 | - Yeah, it's a really difficult question

00:17:57.940 | and you can see why you have such disparity in the ratings.

00:18:01.460 | You even didn't cover one important point,

00:18:05.060 | which is all the like lithium and rare metals

00:18:08.660 | that go into the batteries and stuff,

00:18:11.460 | that all goes in and you're destroying the earth,

00:18:14.300 | ripping it apart and using masses amounts of water,

00:18:18.220 | which the world is short of water in many places.

00:18:22.540 | So it's gonna depend on how you look at it.

00:18:25.180 | And as you point out, yeah, you don't use any gasoline,

00:18:29.140 | but you're creating, you're using energy to charge your car

00:18:33.980 | and where are the power lines and the electricity

00:18:36.420 | and maybe it's a coal plant that's using it.

00:18:38.980 | So it's a very difficult question.

00:18:41.020 | And our recommendation in the book

00:18:43.900 | is really for people to decide on,

00:18:47.620 | okay, I'm gonna go with one rating company

00:18:50.020 | and I'll look at how they do things and just say,

00:18:52.460 | it may not be perfect, it may not align,

00:18:55.220 | but it's better than the alternative of not looking at all.

00:19:00.220 | - All right, now we'll go on to number three.

00:19:02.980 | It is Burton Malkiel's view

00:19:05.780 | that your expectation of return should be lower.

00:19:10.420 | Why would people want to invest in something

00:19:13.580 | in the core of their portfolio

00:19:15.420 | where the expectation of the equity side

00:19:17.500 | is gonna be lower than the market?

00:19:19.580 | - Yeah, it's a very interesting question

00:19:22.340 | and it's actually pretty complex

00:19:24.220 | and we go to a great deal of time in the book

00:19:27.380 | to help people understand the issue.

00:19:29.500 | So let's begin with where I always like to begin,

00:19:31.820 | which is economic theory.

00:19:33.620 | If enough people screen out certain industries or companies,

00:19:38.620 | their P/E will be lower than it would be otherwise,

00:19:42.620 | their cost of their debt will be higher,

00:19:45.260 | they'll pay a higher interest rate

00:19:47.100 | and the screened in companies will get more cash flow

00:19:50.460 | driving their valuations up

00:19:52.700 | and the cost of their debt down.

00:19:55.340 | And that's nice economic theory.

00:19:57.940 | There's also, so you could call that a taste

00:20:02.100 | or a preference-based resulting premium

00:20:05.620 | for being a Brown or SIN investor.

00:20:08.940 | There's also a risk-based story

00:20:10.580 | 'cause if you're a bad polluter,

00:20:12.940 | well, you could get big problems like Exxon Valdez

00:20:17.540 | and have spent billions of dollars in cleanup costs.

00:20:20.860 | If you're a bad employer, you could get headline news

00:20:24.740 | and have massive lawsuits

00:20:26.380 | and no one wants to work for you because you discriminate.

00:20:29.900 | If you have bad governance,

00:20:31.260 | you don't have good risk controls

00:20:33.420 | and those kinds of companies have lots of problems

00:20:36.980 | often manipulating earnings, right?

00:20:39.220 | You get all these accruals.

00:20:41.340 | So it turns out that the companies that have good ratings

00:20:45.220 | tend to be less risky, which is very logical,

00:20:48.500 | less risk of consumer boycotts,

00:20:50.500 | frauds, environmental incidents.

00:20:52.820 | So there's a risk-based story.

00:20:54.860 | If you're a green company,

00:20:56.300 | you're investing in safer companies,

00:20:58.820 | you should expect lower returns.

00:21:00.820 | What's nice in this case is the academic theory

00:21:05.260 | lines up perfectly with the empirical evidence

00:21:08.300 | right up till 2018.

00:21:10.820 | There are studies showing the sin stocks outperform

00:21:14.540 | the non-sin stocks by about 2.5% to 3% a year,

00:21:18.980 | depending upon what factor model you benchmarked it against

00:21:22.620 | or against the S&P about 2.5% to 3% as well.

00:21:27.620 | Along comes this massive trend,

00:21:29.820 | which was like indexing in the '70s, '80s, and '90s,

00:21:33.540 | very slow trickle,

00:21:35.020 | and then it exploded in the last 20 years.

00:21:39.380 | The SRI movement didn't really pick up steam.

00:21:42.300 | It was a little trickle.

00:21:43.500 | And in 2018, it started going way up,

00:21:46.340 | probably because of the impact on climate change

00:21:49.100 | was becoming more evident.

00:21:51.220 | And tens of billions of dollars flew in.

00:21:53.780 | So all of the research, as we show in the book,

00:21:56.340 | where studies end in 2017,

00:21:59.180 | show brown stocks outperforming just as we would expect.

00:22:03.380 | And people could make the decision,

00:22:04.980 | I'm willing to pay that price to express my values.

00:22:08.900 | That's a personal decision.

00:22:11.340 | However, now you have what we call conflicting forces.

00:22:15.380 | All this cash flows are coming in, driving valuations up.

00:22:20.220 | And there was a nice paper called "Dynamic Equilibrium"

00:22:24.060 | that talked about this.

00:22:25.740 | So what they found is from 2018 through 2020,

00:22:29.940 | that three-year period,

00:22:31.980 | even though brown stocks should be expected to outperform

00:22:36.140 | by about, let's call it 3%,

00:22:39.100 | green outperformed by seven.

00:22:42.340 | So there was in effect a 10% greening.

00:22:46.020 | - But it wasn't a lot of that just industry sector.

00:22:48.380 | I mean, most of the green,

00:22:49.380 | or a lot of the green has to do with technology.

00:22:51.820 | You know, Google, Microsoft.

00:22:53.540 | I mean, obviously we had this big growth spurt in tech

00:22:58.500 | like we did in the late 1990s.

00:23:01.220 | And when you look at the ESG footprints of Facebook

00:23:05.060 | and so forth, they score pretty high.

00:23:07.580 | So these portfolios tend to be heavily weighted

00:23:10.700 | towards technology stocks.

00:23:12.260 | And that may have been true during this technology run,

00:23:15.460 | but what's going on this year?

00:23:16.900 | And I don't know if you track it monthly or such,

00:23:19.180 | but isn't it the opposite of what's going on?

00:23:21.340 | I mean, aren't we back to brown again?

00:23:23.940 | - Well, first Rick, your point is absolutely right.

00:23:26.740 | There are certain industries that tend to be more green.

00:23:29.700 | Also, it should be obvious that green stocks

00:23:33.740 | are gonna be more like growth companies

00:23:35.780 | because the brown stocks are screened out.

00:23:38.780 | They're gonna have lower valuations almost by definition,

00:23:42.900 | and therefore are gonna be value.

00:23:44.380 | And that 18 through 20 period

00:23:46.980 | was the biggest drawdown for value in history.

00:23:50.580 | And money was chasing it, as you well aware.

00:23:54.220 | Most investors are performance chasers.

00:23:56.860 | So you had that cashflow pouring in

00:23:59.740 | and driving green stocks up,

00:24:02.140 | and that led to massive outperformance.

00:24:04.420 | And the point we make in the book

00:24:05.940 | is that that trend only made the brown

00:24:10.380 | or SYN premium bigger in the future,

00:24:12.860 | but we're still likely early in the game, Rick.

00:24:15.540 | Only a third of US money about is invested sustainably,

00:24:20.100 | yet the surveys show 80 to 90% of the people

00:24:23.900 | are interested in investing that way.

00:24:26.700 | - Okay, I just have one comment about those surveys,

00:24:30.420 | and then we'll go on to the number four thing.

00:24:32.860 | Okay, I've read the surveys, I've read the questions,

00:24:35.220 | and it's how you ask the question

00:24:37.620 | because the question is generally asked,

00:24:39.820 | if there's no difference in your rate of return,

00:24:42.580 | whether you do ESG or whether you do

00:24:45.220 | a total market index fund,

00:24:47.100 | would you prefer to invest in a way that helps the world?

00:24:50.860 | Yes or no?

00:24:52.180 | And obviously, if you ask the question that way,

00:24:54.260 | the answer is gonna be, oh, no.

00:24:55.340 | I mean, if there's no difference in my return,

00:24:57.500 | then I would invest in a way that helps the world.

00:24:59.580 | - Yeah, you're absolutely right, Rick.

00:25:01.940 | That's why we don't know

00:25:03.620 | whether we're in the third or fourth inning

00:25:05.500 | 'cause we're 33% and it's gonna be 80%

00:25:08.980 | or maybe we're in the eighth inning

00:25:10.580 | and it's 33% and it's gonna go to 40.

00:25:13.340 | Nobody knows, but what we do know

00:25:16.340 | is the demographics favor more of a trend

00:25:19.620 | to sustainable investing 'cause the younger generation

00:25:22.980 | is investing more heavily in that way.

00:25:25.820 | So I think it's likely we're in

00:25:27.980 | maybe the middle innings of this game

00:25:31.060 | where green can continue to at least match

00:25:34.140 | or maybe even slightly outperform,

00:25:36.540 | but I certainly could be wrong.

00:25:38.460 | And this year, as you point out,

00:25:40.140 | with energy stocks leading the way

00:25:42.300 | because of the situation in the Ukraine,

00:25:45.260 | that problem and other related industries benefiting

00:25:50.980 | from that and value is now outperforming again.

00:25:54.900 | So, you know, this year probably Brown is outperforming.

00:25:58.460 | I would not make a bet either way,

00:26:01.020 | but I think there is some good hope people could say,

00:26:05.140 | I wanna invest sustainably

00:26:06.860 | and because of this trends continue,

00:26:08.780 | I may get lucky and have green continue

00:26:12.060 | to at least match and not have to pay a penalty.

00:26:16.660 | - And chapter seven gets to his fourth question,

00:26:19.300 | which is there's no clear evidence that disinvestment,

00:26:23.620 | meaning not owning the Brown stocks,

00:26:26.900 | has interfered with their ability to raise capital.

00:26:30.300 | So in other words, the impact in the market isn't there,

00:26:34.660 | he can't find it.

00:26:36.420 | - Well, I think he's right and wrong at the same time.

00:26:41.340 | So he's right about the point

00:26:43.340 | that it doesn't impact the company's ability

00:26:46.140 | to raise capital because all stocks

00:26:49.420 | have to be owned by somebody.

00:26:51.860 | And if you screen it out or divest,

00:26:54.700 | somebody else is gonna be a buyer.

00:26:56.700 | So there are people who are willing to pay a price,

00:27:00.180 | if you will, and get higher expected returns

00:27:02.820 | and hold their nose to own these Brown companies,

00:27:05.660 | if you will, and expectation of getting higher returns

00:27:08.940 | for their higher risk.

00:27:10.420 | But what it does do is it does mean

00:27:13.380 | you're going to have a higher cost of that capital.

00:27:17.260 | And corporate executives, Rick Ferry is CFO of a company

00:27:21.260 | in the oil industry, let's say it's Shell Oil,

00:27:25.820 | and he sees total petroleum trading

00:27:28.380 | at a higher P/E ratio than them

00:27:31.300 | because it gets a higher rating as a sustainable company

00:27:36.260 | because it is saying,

00:27:37.900 | we're not gonna abandon our energy investments,

00:27:40.820 | but we're not gonna invest anymore in new fields.

00:27:44.860 | We're gonna take all those profits

00:27:47.060 | and invest it in renewable, sustainable sources.

00:27:50.940 | And it turns out the energy industry,

00:27:53.580 | the Brown dirty industry that lots of people exclude,

00:27:57.900 | is generating the most green patents.

00:28:00.140 | And to me, it makes no sense to deprive the good companies

00:28:04.660 | of that capital.

00:28:06.020 | So Malthiel's incorrect.

00:28:08.420 | The evidence as we present in the book is very clear

00:28:11.940 | that corporate executives are taking note of the fact

00:28:15.740 | that if they get poor scores,

00:28:17.940 | their cost of capital is higher.

00:28:20.060 | So they're changing their behavior.

00:28:22.700 | They're trying to make efforts at diversity

00:28:24.940 | to get better social scores, attract employees.

00:28:28.860 | And here's maybe possibly the most important bit

00:28:33.580 | of good news.

00:28:35.020 | We do know that the evidence on corporate profitability

00:28:40.020 | is when you have satisfied employees,

00:28:42.860 | they're more productive and companies are more profitable.

00:28:46.060 | People wanna work for companies that express

00:28:48.940 | and live their values.

00:28:50.780 | And if you have bad scores,

00:28:52.500 | it's very tough to attract people,

00:28:54.780 | especially the younger generation now.

00:28:57.860 | And today we're in the tightest labor market in history.

00:29:01.620 | So corporations are well aware they better get good scores

00:29:05.620 | and you're seeing more action on diversity, climate issues.

00:29:10.500 | And that is changing corporate behavior as well.

00:29:13.580 | There are a whole bunch of studies

00:29:14.860 | which we cite showing these impacts.

00:29:17.860 | And I think you're reading about it in the press

00:29:20.060 | more and more as well.

00:29:21.620 | So I think Matthew was wrong

00:29:23.580 | that it's not impacting their behavior.

00:29:25.980 | It's not cutting them out from capital,

00:29:29.540 | but it is impacting their behavior.

00:29:33.060 | - Okay, so the last question that we have time for today,

00:29:37.820 | it's all been very interesting.

00:29:39.220 | Thank you.

00:29:40.060 | Is that his comments about cost and diversification

00:29:44.580 | or funds are less diversified and more expensive

00:29:49.580 | and may well underperform in the long run,

00:29:51.820 | which we already talked about.

00:29:53.020 | So talk about the cost of doing this and how to do it,

00:29:57.780 | which was the last part of your book.

00:29:59.900 | - Yeah, the costs are, I would say, become pretty reasonable.

00:30:04.540 | The competition in this space

00:30:06.140 | is now like 400 different funds

00:30:09.100 | and fund families like Dimensional, Vanguard

00:30:12.460 | are having sustainable funds

00:30:14.180 | and they are much more lower costs.

00:30:16.940 | You're probably gonna pay a little bit more

00:30:19.020 | to be a sustainable investor

00:30:21.340 | because you're paying for the company

00:30:23.460 | to make the effort to get the ratings, do the due diligence.

00:30:27.300 | But we're talking more about 10 to 15 type of basis points,

00:30:31.660 | not 100 basis points more.

00:30:34.260 | And I think people are willing to make that trade-off

00:30:37.860 | to be able to express their values.

00:30:40.140 | So the costs don't have to be great.

00:30:41.940 | And you can actually build your own sustainable portfolio

00:30:45.580 | with direct indexing.

00:30:47.140 | And because of the technology today, Rick,

00:30:50.260 | you and I know 20 years ago,

00:30:52.340 | you wanted your own SMA or separately managed account.

00:30:56.140 | You probably had a five or $10 million.

00:30:58.620 | Now you could do it with a few hundred thousand

00:31:01.300 | and you don't pay more than, say,

00:31:02.940 | 25 or 30 basis points or so to do that.

00:31:06.940 | - The name of the book

00:31:08.860 | is called "Your Essential Guide to Sustainable Investing"

00:31:11.420 | by Larry Swedroe and Sam Adams.

00:31:13.300 | Larry, thank you so much for being our guest again

00:31:15.660 | on "Bogleheads on Investing."

00:31:17.380 | - Thank you for having me, Rick.

00:31:18.740 | Pleasure to be with you.

00:31:20.620 | - Our next guest is Ellen Quigley.

00:31:22.620 | She is an academic and a consultant

00:31:25.660 | and has a different view.

00:31:27.740 | With no further ado, let me introduce Ellen Quigley.

00:31:31.100 | Welcome to the "Bogleheads on Investing" podcast, Ellen.

00:31:34.340 | - Thank you very much, Rick.

00:31:35.220 | It's a delight to be with you today.

00:31:37.380 | - Ellen, I wanted to have you on the program

00:31:39.140 | because you and I did a podcast together

00:31:41.500 | for the University of California at Berkeley

00:31:43.780 | a few months ago.

00:31:45.340 | And you had some great insights into ESG investing,

00:31:49.820 | responsible investing, and such,

00:31:51.980 | because this has been your area of expertise

00:31:54.740 | as a academic and a practitioner.

00:31:57.500 | So you have really studied this area

00:32:00.580 | and you have some really different ideas about it.

00:32:04.300 | So could you first tell us

00:32:05.620 | a little bit about your background?

00:32:07.620 | - Absolutely.

00:32:08.460 | So I'm from Saskatoon, Saskatchewan in Canada,

00:32:11.820 | and I was going to be a historian.

00:32:14.740 | That was my goal

00:32:16.980 | towards the end of my undergraduate degree

00:32:19.460 | when I started to become increasingly panicked

00:32:22.340 | about the climate crisis.

00:32:23.740 | And it prompted me to take a pause between degrees

00:32:28.740 | that stretched to four years.

00:32:31.340 | And I worked on local environmental issues

00:32:34.220 | before realizing that I was being quite ineffective

00:32:37.100 | and perhaps not even deploying

00:32:41.220 | the kinds of knowledge and tools

00:32:43.940 | that would be useful in a kind of replicability way.

00:32:48.460 | So then I went back to university

00:32:50.420 | with the express goal of learning enough

00:32:53.380 | to contribute in a meaningful way,

00:32:55.500 | and then gradually stumbled towards finance.

00:32:59.580 | And once I got there,

00:33:01.340 | that's when I started to realize

00:33:03.260 | how little any of the accepted tactics

00:33:07.140 | actually had any impact.

00:33:08.660 | - And you ended up getting a master's degree

00:33:12.540 | from University of Oxford,

00:33:14.900 | and then you went on to get your PhD

00:33:17.380 | in economics education from the University of Cambridge.

00:33:21.580 | That's quite a background.

00:33:23.260 | - Well, I've been very lucky.

00:33:25.020 | - Now you are the Senior Research Associate

00:33:29.020 | at Climate Risk and Sustainable Finance

00:33:31.580 | at the Center for Study of Existential Risk,

00:33:34.860 | and also a Special Advisor to the Chief Financial Officer

00:33:38.860 | at the University of Cambridge.

00:33:40.500 | So can you tell us a little bit about your current job

00:33:43.020 | and this advisor role?

00:33:44.780 | - Yes, and I'll just say my comments in this podcast

00:33:47.660 | will be in my role as a Senior Research Associate,

00:33:51.100 | as a senior postdoc,

00:33:52.220 | because I don't want to speak for the university

00:33:55.140 | as the advisor to the CFO.

00:33:57.060 | But basically what I end up doing

00:33:58.580 | is spending supposedly half of my time

00:34:01.420 | researching these issues,

00:34:02.740 | and then the other half of my time

00:34:04.580 | working with various officials within the university,

00:34:07.620 | including the people who manage the endowments

00:34:09.980 | of the 31 colleges at Cambridge as well,

00:34:13.260 | putting pressure on banks and fund managers

00:34:15.700 | to change their practices.

00:34:17.700 | And I'll just say that that has been,

00:34:19.820 | I feel very fortunate to have such an unusual mix

00:34:24.500 | in academia of the pure research

00:34:27.380 | and a lot of freedom on that side,

00:34:28.820 | and then the ability to test things out

00:34:32.140 | in real world environments.

00:34:33.980 | And also because the Bursars are a uniquely skeptical crowd,

00:34:38.980 | they've really helped me think through these issues

00:34:41.300 | in the last few years.

00:34:42.900 | And that's definitely played a big role in the philosophy

00:34:47.900 | I've been cultivating in that time.

00:34:50.620 | - And your philosophy was written out

00:34:53.940 | in a paper that you wrote,

00:34:55.740 | which you submitted to the chief financial officer

00:34:59.700 | of Cambridge back in December, 2021.

00:35:02.980 | So recently called "Universal Ownership in Practice,

00:35:06.740 | a Practical Investment Framework for Asset Owners."

00:35:09.860 | And I found the paper to be very enlightening,

00:35:12.340 | very interesting.

00:35:14.340 | Let's first talk about the paper itself,

00:35:17.980 | because this idea of universal ownership

00:35:21.460 | is different than ESG.

00:35:24.300 | Could you talk about what it is, universal ownership?

00:35:27.980 | - In a way, universal ownership is the opposite of ESG.

00:35:31.980 | Despite, in many people's minds, having the same goal,

00:35:35.940 | they really end up lending themselves

00:35:38.460 | to very, very different tactics.

00:35:41.180 | So this paper I wrote, the idea behind it

00:35:44.220 | is to evaluate the efficacy or lack thereof of ESG.

00:35:49.220 | And by that, I mean, what are the real world outcomes

00:35:52.980 | associated with ESG practices?

00:35:56.300 | If you look at the philosophy, the kind of approach,

00:35:59.980 | ESG is meant to shield an investment, a company,

00:36:04.940 | a portfolio from environmental,

00:36:07.860 | social and governance risks.

00:36:10.020 | It's not actually designed to do anything

00:36:13.460 | about those risks in the real world.

00:36:15.500 | And what universal ownership does

00:36:17.220 | is it flips things around.

00:36:19.300 | And it says, "Instead of trying to narrowly protect

00:36:21.540 | my own portfolio from something like climate change,"

00:36:24.460 | which by the way, surely is impossible.

00:36:27.820 | I can't imagine a portfolio that you could construct

00:36:31.100 | for 2050 that would be somehow immune

00:36:33.820 | to the effects of climate change.

00:36:35.780 | Instead of attempting to do the impossible

00:36:37.900 | and construct some magic portfolio,

00:36:40.380 | a long-term investor of capital,

00:36:43.340 | so this could be a retail investor with an index fund,

00:36:46.980 | it could be a big pension fund

00:36:49.740 | with very long-term time horizon for investing.

00:36:52.940 | They're going to want to preserve

00:36:54.620 | where most of their returns come from,

00:36:57.260 | which happens to be the health of the overall economy.

00:37:01.380 | Most returns come from that,

00:37:03.580 | not your ability to outperform the market.

00:37:07.180 | I mean, this is kind of some of the wisdom

00:37:08.300 | behind tracker funds.

00:37:10.820 | Actually, it just, it recognizes

00:37:12.540 | that fees can cut into the big bulk of your returns,

00:37:17.100 | which is this overall market performance.

00:37:20.420 | And so what universal ownership does is it says,

00:37:22.780 | "What can I do using the tools available to me

00:37:25.820 | as an investor to internalize externalities,

00:37:29.220 | to reduce systemic risks that are created

00:37:31.580 | by the companies that I own?"

00:37:34.700 | And once you have that philosophy,

00:37:36.220 | you use pretty much the opposite tools.

00:37:39.540 | - Just to clarify, here in the U.S.,

00:37:41.900 | the, an index fund or a broad market index fund

00:37:46.180 | is called a tracker fund in the U.K.

00:37:49.620 | 'cause it tracks an index.

00:37:50.780 | So it's a little bit different lingo.

00:37:52.220 | - Ah, interesting.

00:37:54.380 | - Okay, I want to spend some time

00:37:57.460 | on the problems with ESG investing,

00:38:00.500 | because I think that there's a lot of misconception

00:38:02.580 | about what it's supposed to do.

00:38:04.740 | I think that here in the U.S.,

00:38:07.660 | it's been sold by the fund providers

00:38:10.740 | as having an impact on society

00:38:13.900 | and have an impact on climate change.

00:38:15.500 | In other words, if you don't invest in these companies,

00:38:18.500 | if you disinvest from these companies,

00:38:20.860 | they'll get the message and they'll change

00:38:23.300 | because they want you to own their stock.

00:38:25.500 | Is there any truth to that?

00:38:27.140 | - Well, I can't find any.

00:38:29.740 | Let me just distinguish between two things, though,

00:38:32.620 | that's quite important.

00:38:33.940 | So there are some suggestions

00:38:36.380 | that if you are a politically important

00:38:39.540 | or legitimate institution

00:38:41.100 | and you make a big announcement stigmatizing,

00:38:44.580 | say, fossil fuels,

00:38:46.660 | the argument there that I think does hold water

00:38:49.940 | based on the research behind the divestment report

00:38:52.980 | I wrote for the University of Cambridge,

00:38:54.980 | I'm now somewhat persuaded

00:38:57.060 | that if you have a big announcement

00:38:59.940 | from a really legitimate institution,

00:39:02.460 | it can help to stigmatize an industry

00:39:04.620 | that needs to be legislated

00:39:06.340 | and can't be meaningfully legislated

00:39:08.860 | until it's viewed as sufficiently bad

00:39:13.220 | to invite that legislation.

00:39:14.940 | So it basically is the precondition

00:39:17.140 | to getting the government action that we need

00:39:19.420 | is the argument for, say, a divestment announcement.

00:39:23.660 | But in terms of direct impacts from the sale of shares,

00:39:27.860 | most of which, by the way,

00:39:28.740 | are not accompanied by an announcement of any kind,

00:39:31.300 | so there's no stigmatizing effect,

00:39:33.900 | I just can't find anything other than

00:39:36.020 | either a very momentary blip in share prices

00:39:39.300 | that quickly reverts to the mean

00:39:41.180 | and actually accompanying the day of the announcement

00:39:43.780 | of a very large share sale

00:39:45.940 | as opposed to the day of the sale,

00:39:47.940 | which tells you it's much more about perception

00:39:50.340 | than anything else.

00:39:52.500 | And then there are some stocks,

00:39:54.420 | such as in tobacco industry, for example,

00:39:56.460 | where there's been a mild depression of share prices

00:40:00.780 | over time because it's the longest running

00:40:04.380 | excluded industry, basically.

00:40:06.980 | But even then, it doesn't affect the company's behavior.

00:40:11.620 | I mean, tobacco companies have continued to sell cigarettes

00:40:14.580 | this entire time despite being the most targeted

00:40:18.100 | by ESG investors for decades.

00:40:20.420 | So I can't find the evidence that people would need

00:40:25.420 | to conclude that having filters or exclusions

00:40:29.580 | on a public equity portfolio makes any difference at all.

00:40:33.500 | - So most ESG funds are just buying stocks on the market

00:40:38.500 | or they're excluding stock, divesting stock.

00:40:44.220 | And this is meant, at least in some people's mind,

00:40:49.220 | the way it's sold here, as though you're making a difference.

00:40:53.740 | But in fact, from what you're saying,

00:40:56.380 | is if the stock is already out there in the public domain

00:40:58.820 | and it's just being traded among different owners,

00:41:01.980 | that there is no difference.

00:41:03.380 | There is no impact.

00:41:04.420 | - Yeah, and I think it stems from the way that we use

00:41:07.700 | the language in this area.

00:41:09.740 | And I was in this camp as well initially

00:41:12.700 | because I didn't know anything about finance many years ago.

00:41:16.060 | And the term investing, if you think,

00:41:18.020 | oh, I'm investing in something,

00:41:19.380 | you think you're contributing money to it, right?

00:41:23.180 | And I think that's the fundamental misconception here.

00:41:25.900 | Because if you're investing in Shell or Exxon,

00:41:30.340 | Exxon or Shell, they're not getting your money.

00:41:32.820 | Your money is going to a different shareholder,

00:41:35.580 | a now former shareholder.

00:41:38.180 | None of it flows back to the company.

00:41:40.060 | They don't care who owns their shares

00:41:41.740 | as long as they don't cause trouble in one way or another.

00:41:45.220 | But there's no evidence to suggest

00:41:47.340 | that that composition of shareholders

00:41:50.620 | has had a significant effect.

00:41:53.620 | I mean, the causal relationship between selling your shares

00:41:57.140 | and company behavior change,

00:41:58.940 | especially anywhere close to the scale that's needed,

00:42:01.580 | is just not there.

00:42:03.260 | - You know, I've always found it strange

00:42:04.580 | that the idea that by not investing in a company,

00:42:09.060 | you're going to make a change in the company,

00:42:11.460 | where I was always learned when I was in business school,

00:42:14.300 | that it's the owners of the company, the shareholders,

00:42:16.820 | the voters, the people who vote,

00:42:18.940 | are the ones that make the difference,

00:42:20.140 | not the people who have no affiliation

00:42:23.140 | with the company in any way and are not shareholders.

00:42:25.540 | So this idea of not owning stocks,

00:42:28.900 | where you're not going to be voting any shares,

00:42:31.860 | how can you make a difference?

00:42:33.740 | It doesn't do anything for ESG.

00:42:36.980 | It doesn't do anything to change the world,

00:42:39.380 | but it might make you feel better.

00:42:42.580 | - Yeah, which is actually a bit concerning

00:42:45.380 | for a couple of reasons.

00:42:47.060 | One being that the fact that you've invested in an ESG fund

00:42:51.100 | almost always means that you've paid higher fees.

00:42:53.860 | And I actually do subscribe to what Tarek Fancy,

00:42:57.460 | the former head of sustainable investing at BlackRock,

00:43:00.300 | has said, which is that ESG is a dangerous placebo.

00:43:03.380 | Because I think that if people think they've done their job,

00:43:06.060 | they've invested in an ethical manner,

00:43:08.740 | they're likely to just kind of walk away

00:43:10.380 | from that whole arena of impact as job done.

00:43:15.220 | And actually, if they're doing something that has no effect,

00:43:18.500 | but they've left it alone thinking that it's sorted,

00:43:21.300 | that's more dangerous, actually,

00:43:22.980 | than not persisting in that belief.

00:43:27.060 | - Hmm, well, let me ask you this,

00:43:29.340 | because it's something that I have believed for a long time.

00:43:32.020 | I've been in the investment business for 35 years,

00:43:35.100 | and before there was ESG,

00:43:37.220 | there was socially responsible investing.

00:43:40.220 | Always looked at this

00:43:41.060 | and looked at the fees associated with it,

00:43:43.140 | and never really believed that this was having any impact.

00:43:47.180 | There is a lot of belief among many advisors

00:43:51.100 | that if you didn't do ESG investing,

00:43:54.900 | in a typical ESG fund,

00:43:57.820 | if you just put your money in a broad market index fund

00:44:01.100 | that had extremely low cost fees,

00:44:03.820 | that you take the fee savings that you get from doing that,

00:44:08.100 | and then you donate that to whatever cause you believe in,

00:44:12.220 | you'll have a much bigger impact

00:44:14.300 | than you would doing ESG investing.

00:44:17.060 | - I think that's almost certainly true,

00:44:19.340 | but I would take it a step further.

00:44:21.860 | And this is coming from the work of Oliver Hart.

00:44:25.140 | He's provided some really interesting insight in this space.

00:44:29.020 | He talks about the comparative advantage

00:44:31.020 | that a company has in internalizing externalities.

00:44:34.900 | And that's quite interesting, right?

00:44:36.300 | He talks about this case in which DuPont Chemical

00:44:40.500 | had the choice of disposing responsibly of some chemicals

00:44:44.100 | at the cost of 19 million,

00:44:45.820 | or dumping them in the Ohio River,

00:44:47.900 | as actually did occur in the '80s.

00:44:50.900 | And when litigated, they discovered that the cost

00:44:53.700 | to the rest of the economy was actually 350 million

00:44:57.260 | from that spillage, right?

00:44:58.460 | So having prevented it in the first place

00:45:01.660 | would have been much better.

00:45:03.340 | If you think about what charitable donations could do

00:45:06.660 | to counteract the effects of things

00:45:08.660 | that would have been prevented in the first place,

00:45:10.780 | I think you might want to do two things.

00:45:12.820 | I think you may want to still donate to charities

00:45:15.700 | and so on and so forth,

00:45:16.740 | but I would also make sure to only work with a fund manager

00:45:21.740 | who's willing to help actually get those companies

00:45:25.020 | to internalize externalities.

00:45:27.460 | And that's rare.

00:45:28.420 | Most fund managers are not doing the things

00:45:31.420 | that we would need them to do

00:45:32.980 | to help move companies in that direction

00:45:35.580 | and prevent much greater costs from being absorbed

00:45:38.740 | both by society, but also other companies

00:45:40.900 | in your portfolio, right?

00:45:42.660 | That's the reality of externalities,

00:45:44.500 | is that they end up depressing the whole market

00:45:47.460 | and that's something that we could prevent

00:45:50.580 | as owners of companies.

00:45:51.900 | - Your paper is on universal ownership.

00:45:55.540 | So could you describe for us,

00:45:58.100 | how do you invest with a universal ownership mindset?

00:46:03.100 | - It's a really important question.

00:46:06.140 | I think it's probably one that will still be debated

00:46:08.460 | for some time.

00:46:09.300 | But what is clear is if you're a universal owner,

00:46:12.020 | as in you own a little bit of everything,

00:46:14.900 | and this can be because you're an individual

00:46:17.060 | with an index fund or because you're a big pension fund

00:46:20.940 | and you do just kind of automatically

00:46:24.180 | end up owning a bit of everything,

00:46:26.940 | then you have to worry about the whole portfolio.

00:46:30.100 | When you look at the entire portfolio,

00:46:32.300 | you can't just think about profit maximizing

00:46:34.700 | each individual company or holding

00:46:37.940 | because that can actually end up hurting

00:46:40.180 | the overall performance of your portfolio.

00:46:42.980 | And I might just use Exxon as an example here.

00:46:45.820 | If you're a universal owner,

00:46:47.140 | you may not want Exxon to profit maximize

00:46:51.020 | to its fullest extent because that would impose costs

00:46:55.300 | on everything else in your portfolio,

00:46:57.140 | especially over the long-term

00:46:59.100 | because of carbon emissions and climate change.

00:47:02.740 | And Exxon is actually responsible for something

00:47:05.100 | like two or 3% of all historical emissions.

00:47:07.460 | You can actually attach some real figures

00:47:10.660 | to the damage already caused by Exxon

00:47:13.300 | across one's portfolio in agriculture

00:47:15.860 | and real estate and insurance and food systems.

00:47:20.020 | You name it, pretty much every sector is already affected

00:47:23.460 | and that's slated to increase.

00:47:25.220 | So if you're a universal owner,

00:47:27.180 | you have to think, actually,

00:47:29.020 | I would prefer that Exxon adopt a transition approach

00:47:33.860 | and every other company to do so as well

00:47:35.980 | because even if it costs Exxon a bit more to do that,

00:47:39.740 | the overall effect for my portfolio is improved.

00:47:43.500 | So that's the idea.

00:47:45.060 | And then practically speaking,

00:47:46.340 | how you implement that is you have to think,

00:47:48.780 | well, what is going to actually change a company's behavior?

00:47:51.940 | And we've already talked about how selling

00:47:54.220 | that company's shares in the secondary market

00:47:56.700 | probably isn't going to have an effect.

00:47:59.220 | So what do you do instead?

00:48:01.380 | Well, a company like Exxon,

00:48:04.940 | but when building, say, new fossil fuel infrastructure,

00:48:08.860 | a fossil fuel company will probably raise debt.

00:48:11.940 | In fact, that's how a very large majority

00:48:14.540 | of new capital for fossil fuels is raised, through debt.

00:48:18.860 | About 90% is the approximate estimate.

00:48:22.060 | And that comes from loans and from debt issues, bonds.

00:48:26.420 | And that means that actually a big focus,

00:48:29.180 | if you're a universal owner,

00:48:30.220 | should be on what banks are financing

00:48:32.460 | because it's not a very large proportion

00:48:35.100 | of their loan book that will be dedicated

00:48:38.780 | to something like fossil fuels,

00:48:40.060 | but the impact will be huge and systemic.

00:48:42.780 | So that's a good target for the types of engagements

00:48:46.060 | that you may want to have as an investor.

00:48:48.340 | I just want to understand what exactly you're saying.

00:48:50.540 | You're saying that the way to have an impact

00:48:54.260 | on company's behavior is when they need money.

00:48:57.180 | Yes.

00:48:58.020 | And when they're trying to raise money.

00:48:59.740 | Yes.

00:49:00.580 | And that's when you bring up these issues

00:49:02.980 | as a potential investor?

00:49:04.620 | Yes.

00:49:05.460 | And why that's as important is that there are some studies

00:49:08.140 | to suggest that, let's say you're a company

00:49:11.020 | wanting to raise debt with a bond issue,

00:49:14.100 | you can raise more money and at a better price

00:49:17.180 | if you have lots of demand.

00:49:18.700 | And the inverse is also true.

00:49:20.220 | If you don't have sufficient demand,

00:49:22.460 | you're going to be able to raise less money

00:49:24.220 | and at a higher cost.

00:49:25.700 | And the same is actually true for initial public offerings.

00:49:28.940 | That's when a company goes onto the stock market

00:49:31.420 | for the first time.

00:49:32.580 | The same thing is true.

00:49:33.700 | If you have a lot of demand,

00:49:35.100 | you can raise more money and at a better price.

00:49:36.940 | So this is the reason that it's so important

00:49:39.820 | to look at primary market investments

00:49:42.660 | as those in which you'll have the most direct effect.

00:49:45.860 | And I like the way you phrased that, Rick,

00:49:47.580 | because it's a two-parter.

00:49:50.140 | One is that probably there are certain companies

00:49:52.540 | you should be denying debt to,

00:49:54.500 | as in you should not be participating in new issues

00:49:57.740 | for those companies.

00:49:58.820 | But what you're talking about, too,

00:50:00.340 | is the pressure that you can actually put on at that moment,

00:50:02.980 | the kinds of engagement that you can have

00:50:05.100 | when a company is looking for new cash.

00:50:08.260 | That's a lot more leverage than you might otherwise have.

00:50:11.580 | And the other big lever as an investor,

00:50:13.500 | let's say that you retain shares in this company

00:50:16.700 | that you want to change the behavior of

00:50:19.980 | and you've denied debt to that company.

00:50:22.260 | Well, as an owner of the shares,

00:50:24.380 | there's been a huge focus on shareholder resolutions.

00:50:27.260 | Tons of those get filed every year,

00:50:30.020 | and they tend to be disproportionately

00:50:32.340 | about environmental or social issues.

00:50:34.460 | So they kind of get a lot of the attention of the ESG crowd.

00:50:38.500 | - Let me circle back to something I said before.

00:50:40.220 | If you're excluding these companies from your portfolio,

00:50:43.340 | then you have no ability to put in

00:50:46.500 | a shareholder resolution.

00:50:48.620 | So it seems like it's counterproductive

00:50:50.580 | to not own the stock of the company

00:50:53.580 | if now you have no say in the company.

00:50:55.500 | - Yeah, exactly.

00:50:56.660 | Unfortunately, the skepticism

00:50:58.380 | should stretch a little bit further.

00:51:01.420 | I now am not sure if shareholder resolutions

00:51:04.980 | are that effective themselves.

00:51:07.100 | There are better tools available to investors in a company.

00:51:10.580 | So just to say quickly why shareholder resolutions

00:51:13.020 | may not always be the best way to go,

00:51:15.620 | they tend to be about disclosure only.

00:51:17.860 | And that goes back to the philosophy of ESG, by the way,

00:51:21.380 | because ESG is all about trying to identify

00:51:24.460 | the risks to your portfolio

00:51:26.260 | so that you can stock pick more effectively, basically.

00:51:28.980 | So the disclosure of risks is what's useful

00:51:31.620 | to someone with that mindset.

00:51:33.220 | But disclosure itself can't be meaningfully connected

00:51:37.420 | to actual real world outcomes.

00:51:39.620 | There are quite a few studies on this,

00:51:41.580 | and it's difficult to conclude from those

00:51:44.460 | that there's the straight line between improved disclosure

00:51:47.460 | and improved environmental performance, say.

00:51:50.420 | - Are there any other tools,

00:51:52.020 | big tools available to investors?

00:51:54.220 | - Yeah, I've left the best till last, I guess,

00:51:58.500 | which is that if you vote against

00:52:00.900 | the re-election of directors,

00:52:02.300 | that is probably the greatest power available

00:52:05.620 | to an investor in a company.

00:52:07.620 | And there aren't enough studies on this, I will say,

00:52:11.100 | and we need more research on it.

00:52:13.740 | But it does look like you can start to see some responses

00:52:16.820 | at the company level long before you actually win that vote,

00:52:20.540 | because, and this is the idea behind it,

00:52:23.620 | that very high-status individuals

00:52:26.340 | who tend to serve on boards are personally embarrassed

00:52:29.540 | if they have votes against, even to the tune of 10% or 20%,

00:52:34.540 | that would be quite a huge embarrassment

00:52:37.780 | to a high-status individual.

00:52:41.260 | And you do tend to see, then,

00:52:43.580 | greater company-level responses to that.

00:52:47.860 | And if you think about what could be deployed

00:52:51.020 | in that regard on climate,

00:52:53.660 | you could start to imagine that you could do something

00:52:55.900 | across whole sectors, saying here is an objective standard

00:52:58.940 | that's set by science, and here's what would have to happen

00:53:02.460 | for us not to vote against your directors,

00:53:04.380 | and do something that applies to a whole sector

00:53:07.620 | so that there isn't a disadvantage

00:53:09.460 | to those who are decarbonizing on schedule, say.

00:53:13.340 | It's all about voting against directors and denying debt.

00:53:16.260 | If I had to pick two tactics as a universal owner,

00:53:19.980 | it would be those two things,

00:53:21.660 | because they're the sharpest tools in the toolbox.

00:53:25.940 | - Ellen, what type of progress do you think is being made

00:53:30.380 | in the industry, in the investment management industry,

00:53:34.940 | towards this universal ownership concept?

00:53:39.620 | - It's a really interesting,

00:53:41.780 | I mean, I have to give a depressing response,

00:53:45.540 | which I'm sorry to say, it's okay.

00:53:49.420 | - Sorry.

00:53:50.260 | - I think we're just, we're not there yet at all.

00:53:53.500 | People are still, at best, in an ESG mindset,

00:53:58.420 | and I'm hoping that we can see a leapfrog, frankly.

00:54:03.420 | Because of the pandemic, we have a greater understanding

00:54:07.020 | of systemic risks, an instinctive understanding

00:54:09.540 | of systemic risks, and I'm hoping that that will allow us

00:54:12.580 | to go straight to universal ownership

00:54:15.580 | instead of passing through ESG.

00:54:18.580 | But I also have concerns about the conflicts of interest

00:54:21.100 | of very largest fund managers,

00:54:23.900 | which are trying to bid for the business

00:54:27.060 | of the pension funds of these big companies

00:54:29.620 | that are contributing externalities to the system.

00:54:32.860 | So I find it very unlikely that they are going to be

00:54:34.900 | the ones to lead the charge, and in fact,

00:54:37.020 | that has been borne out in terms of ESG adoption as well.

00:54:42.020 | My hope is squarely on pension funds,

00:54:46.540 | potentially some sovereign wealth funds,

00:54:48.100 | and endowments, foundations, et cetera.

00:54:51.700 | I think that's probably where we're most likely to see

00:54:55.100 | that leapfrogging towards universal ownership.

00:54:59.220 | - Well, I'm circling back to my ESG fund argument

00:55:01.780 | here in the United States, where neither one of those

00:55:04.700 | are being utilized by ESG funds here in the US.

00:55:08.300 | You have no voting power.

00:55:10.860 | The weak one, the resolution, if it even works,

00:55:15.100 | you don't even have that option.

00:55:16.260 | You don't have the option to vote out board members

00:55:19.740 | that may have a different viewpoint,

00:55:21.820 | and since you're just trading equity

00:55:25.300 | or not trading equity on the exchange

00:55:27.820 | in the secondary market, these funds are not involved

00:55:30.980 | in the primary market.

00:55:32.060 | So there's really nothing of all of your research

00:55:35.700 | that actually shows that it might work.

00:55:38.660 | Let's talk about one last thing,

00:55:40.100 | and that is government involvement.

00:55:42.020 | In your paper, you were very specific to talk about

00:55:46.100 | one way you could really make change

00:55:50.220 | is through laws and regulations.

00:55:52.820 | From an ESG investing standpoint,

00:55:55.660 | I mean, maybe there is something going on here

00:55:58.740 | in the United States where politicians

00:56:00.260 | are becoming more aware of,

00:56:03.180 | a lot of people are investing via ESG,

00:56:05.580 | so maybe they're becoming more aware of this,

00:56:08.540 | and maybe that is influencing at least what they talk about

00:56:11.820 | in Washington.

00:56:12.900 | Could you talk about, as far as from the investment level

00:56:16.180 | to the government level, how does that shift take place?

00:56:18.660 | I haven't seen any studies on this,

00:56:20.860 | so I just wanna leave open the possibility

00:56:24.300 | that that can help to provide support

00:56:27.340 | for government legislation.

00:56:28.540 | If people see that people are willing to put their money

00:56:31.860 | where their values are, whether or not that's misguided

00:56:34.980 | or not, as you and I have discussed,

00:56:37.340 | that, who knows, that could contribute

00:56:39.140 | to a politician's level of comfort

00:56:41.700 | with enacting legislation in line

00:56:43.460 | with those revealed beliefs.

00:56:47.460 | I'm trying to actually give some reason

00:56:49.420 | for people to invest in ESG here in this country

00:56:52.940 | who want to, without slamming them too bad here,

00:56:55.260 | saying, "Well, look, even though it's not doing anything

00:56:57.300 | "for your portfolio, maybe by investing this way,

00:57:02.300 | "maybe it's in the media, you've got fund companies

00:57:08.300 | "creating ESG funds left and right

00:57:10.300 | "using all different things."

00:57:11.260 | I mean, it's in the news, and therefore,

00:57:13.340 | it's getting the attention of politicians.

00:57:16.180 | And is that having some effect?

00:57:18.380 | - Yeah, I think it probably is.

00:57:22.420 | Again, I don't have studies on this,

00:57:24.580 | so this is just an opinion, but I think it's unlikely

00:57:28.460 | that you would see this level of media coverage

00:57:32.220 | of a phenomenon without its having any effect

00:57:35.220 | on both company practices and politicians' willingness

00:57:38.860 | to enact legislation in line with it.

00:57:41.300 | And I think we are increasingly seeing companies

00:57:43.820 | kind of flailing about trying to figure out

00:57:45.820 | how to maximize their ESG scores and so on and so forth.

00:57:49.820 | By the way, I find ESG scores to be problematic as well.

00:57:54.220 | But I think it's unlikely that you would see

00:57:58.140 | this level of interest in a phenomenon

00:58:00.620 | without its having those larger effects.

00:58:05.140 | - Well, I'm just trying to come up with a reason

00:58:07.740 | why people would invest in ESG funds in this country.

00:58:11.100 | So that might as well be something that we can hang on to.

00:58:15.020 | Maybe, maybe it's making some sort of a political impact.

00:58:18.460 | Maybe. - Maybe.

00:58:19.980 | - Well, Ellen, thank you so much.

00:58:20.980 | Greatly appreciate your time today

00:58:23.420 | and your work that you're doing,

00:58:25.380 | and I wish you all the luck in the world.

00:58:27.180 | - Thank you so much, Rick.

00:58:28.020 | And it's a real pleasure to talk to somebody

00:58:30.380 | who instinctively gets this.

00:58:33.060 | - Well, thank you.

00:58:34.220 | - This concludes this edition of "Bogleheads on Investing."

00:58:37.140 | Join us each month as we interview a new guest.

00:58:40.060 | In the meantime, visit boglecenter.net, bogleheads.org,

00:58:44.340 | the "Bogleheads" wiki, "Bogleheads" Twitter.

00:58:46.780 | Listen live each week to "Bogleheads Live"

00:58:49.060 | on Twitter Spaces, the "Bogleheads" YouTube channel,

00:58:51.740 | "Bogleheads" Facebook, "Bogleheads" Reddit.

00:58:54.700 | Join one of your local "Bogleheads" chapters

00:58:57.620 | and get others to join.

00:58:58.980 | Thanks for listening.

00:58:59.980 | (upbeat music)

00:59:02.580 | (upbeat music fades)

00:59:05.660 | (upbeat music)

Bogleheads® on Investing Podcast 046: Larry Swedroe and Ellen Quigley on ESG Investing

Chapters