Environmental, social and governance (ESG) issues have been at the forefront of investment practice for many years. A key concern for investors, however, is the lack of quantitative criteria for defining ESG rankings. In fact, many companies are adding defense stocks only after changing his ESG guidelines.
In a recent interview with ValueWalk, Constrained Capital’s Mark Neuman explained that there is no rhyme or reason to how ESG rankings are assigned to companies. This fact is further evidenced by his changes to ESG guidelines on defense and weapons stocks. Constrained Capital is an investment manager that seeks to capitalize on the distortions created by participants selling in areas such as his ESG investments.
Fluid ESG criteria
Neuman said when the war in Ukraine erupted at the end of February, there was talk that he might change the taxonomy of ESG investing to include defense stocks for the social impact “S” component. said. He believes ESG professionals have considered changing this taxonomy over the years to allow a broader definition of what is included in an ESG rating.
When he first started looking at the ESG industry, the discovered manager found 8-10 rating agencies, including ISS, Sustainalytics and Bloomberg ESG. However, this number has now ballooned to almost 20. Further digging into these rating agencies reveals that all three factors differ significantly in how they calculate each company’s rating.
“In my research, I found that E, S, and G ratings by many agencies vary from company to company,” Mark says. “For example, depending on the rating agency, he may find an E rating for a particular company in the lower-middle-upper quartile distribution. There is little consistency across ESG ratings.”
He added that all these different ratings are causing significant confusion for investors. This confusion is compounded by talk of changes in the rating system and how companies can be seen as more ESG-friendly over time, which also varies by rating agency.
“Nobody really knows the rules of what is and isn’t allowed,” says Neuman. “After looking at the rating system, and from a risk standpoint, I fear that looking back at the global financial crisis of 2007-2009 will remind us that AAA-rated CDOs were in fact complete junk. “Who’s the victim? The market and the investors. There’s a pattern similar to the ratings agencies that are now being bought by Wall Street.”
According to Mark, the problem is the many gray areas of ESG. He believes his ESG concept is a good one, but he also thinks Wall Street has turned it into an “amorphous blob.” He noted that Wall Street continues to issue and reissue more and more of his ESG funds, but they serve no one but the companies and managers that created them.
Neuman says these ESG funds will allow managers to amass more and more assets and fees. But he also blamed his ESG for the inherent risk build-up he sees.
“You can clearly see it at gas stations and grocery stores,” opined Mark. The ESG movement continues to say they are happy to eliminate fossil fuels and nuclear energy from their day-to-day business.
He looks at all areas shunned by ESG, including arms and defense, fossil fuels, and the nuclear space in utilities, all of which are to some extent “very reasonably valued” against the S&P 500. I discovered that were his top three beneficiaries of ESG inflows.
Defense and fossil fuel stocks as ESG
Opinions are fluid about what should and should not be included in light of current events affecting the planet. In particular, Russia’s invasion of Ukraine put his traditional ESG views of weapons companies and fossil fuels under the microscope.
Neumann believes that defense stocks have now become “apolitical.” So, neither blue nor red, neither Democrat nor Republican. In addition to the war in Ukraine, the escalating conflict between Taiwan and China is also a factor in the defense stockpile, he said. Democrats have traditionally opposed defense spending, but Bernie Sanders has awakened China’s ambitions to potentially seize Taiwan.
“These are important securities with national interest now,” the fund manager said. “Everybody participates to some degree.”
He also pointed out that nuclear energy is equally important for military use, not only as renewable energy, but also in submarines and aircraft carriers that can stay at sea for long periods of time when using nuclear power.
“These two important sectors are now intertwined,” explains Neuman. “Let’s take a half step back. The Biden administration is greening its weapons…it will be Raytheon, Guidant, Lockheed Martin.
He also noted that Kyiv is not buying pickup trucks when Washington sends aid to Ukraine. I am buying. They are not buying from Russia.
“I think this is a non-political and important issue,” he added. “I am strictly a CFA
Neuman is often asked if anyone is against ESG, and he stressed otherwise. From going plastic bottle free to supporting his son when he goes to Peru to plant samples on a service trip, he does what he can for the environment outside the investment world. He believes that if people planted more trees, the environment would be better.
“We live a very ESG life locally,” he added. “We eat leftovers. We don’t throw anything away. We recycle everything. We’ve lost 99% of the plastic bottles in our house. Skiing, scuba diving, Take a walk in the mountains, we like them, we believe in them, but as an investor, Wall Street’s acquisition of ESG investing has made ESG investing unrecognizable.”
Neuman argues that ESG hurts investor returns. Especially because investors pay higher fees for her ESG-focused vehicles compared to lower fees for other types of investment vehicles that generate similar returns. He also believes there is a fair amount of risk inherent in the constant recycling of ESG stories.
Recalling a famous quote by Fidelity’s Peter Lynch when he advised investors to know what they own, Neumann said ESG investors know what they own. said no.For example, he said that Amazon
“There are many choices and choices being made that are incompatible and misguided with living a clean ESG life,” he added.
The fund manager emphasized that while the most common ESG names are “over-owned and crowded,” stocks shunned by ESG are “not over-owned.” , believes it brings a good balance to their portfolio construction when investors look for underinvested and underowned stocks. He added that he intends to help investors manage their funds to achieve better-than-average returns.
Why ESG must change
He also pointed out that others are using lawsuits to start opposing ESG. For example, Florida Governor Ron DeSantis has decided that the state’s pension funds will not use his ESG guidelines for investments.
In addition, several state attorneys general have asked BlackRock to explain its position. Using the Employee Retirement Income Security Act, better known as ERISA, the Labor Department is also beginning to question ESG in its fiduciary role, comparing ESG to pure altruism with no interest in returns. It also questions how will affect financial returns. The Supreme Court also told the Environmental Protection Agency that it may be overstepping its bounds on how companies should behave.
“ESG, as we know it, must change,” adds Neuman. “I don’t think it’s two switches on and off. It’s more three-dimensional. But I believe the ESG landscape is a major industry with trillions of dollars in assets and billions in regulatory and service fees and revenues.”
Mark is concerned that for many participants in the ESG ecosystem, their livelihoods depend on ESG continuity. As a result, he suspects their concern is to perpetuate ESG using the explanation that it is for the environment and society.
However, Neuman’s observations and research suggest that investors are falling short of their ESG goals. He also warned that some of his biggest ESG fund managers may be more interested in collecting assets under management and raising fees than his ESG.
As such, Neuman advises investors to exercise caution when investing in ESG, protect themselves, and find sensible ways to manage risk. He also believes investors should hedge his ESG investments. This ETF consists of stocks that have been shunned by ESG funds. This allows investors to hedge the risks associated with his ESG-focused investment vehicles, which typically include very crowded names.