ESG: environmental, social and governance, is this the right approach?

Moral reasons for investing and a good long term strategy?

Article updated: 7 August 2019 11:00am Author: Michael Baxter

There are two reasons why investors might consider ESG — environmental, social and governance investing — for moral reasons, or because they think it is the best strategy for long-term returns.

I am going to focus on the second motivation today, the first is, frankly, none of my business, that one’s down to you.

I will begin with a mystery. Why are there still tobacco firms? Or re-word that, why haven’t they been fined trillions of dollars? Truth is, their products are responsible for the premature deaths of millions of people, including both my parents. BP’s bill for the Gulf of Mexico oil spill was in excess of $62 billion. Yet I would say the damage done by tobacco dwarfs the damage caused by the infamous oil spill. Furthermore, I suspect that the tobacco firms knew about the dangers of smoking early on, before it was common knowledge. Their PR strategy was not exactly open about the dangers of smoking.

I note that the Imperial Tobacco share price is up more than four-fold since it was listed on the stock exchange in 1996.

But I also note the share price has virtually halved since 2016, regulatory change is a factor behind this.

The theory

In the long run, in theory, our bad deeds catch up with us.

Let me take two examples: climate change and privacy.

Actually, I don’t sign up to the view that human made climate change is proven, I just think it is highly likely. Just as it is possible that human activities are not affecting the climate to the extent we are told, I also think it is possible that we are underestimating the impact of human activities on the climate. Unfortunately, I think that the second possibility is more likely than the first.

But the reality that investors have to grapple with (I wish non-investors did, too) is that nothing is certain, we can only deal with probabilities and likelihoods.

The lesson of the tobacco firm’s share price is that it doesn’t seem to matter if your core product is not that different from slow acting poison. Maybe vaping, which may prove to be less dangerous than smoking, will be the ultimate downfall of the tobacco firms; maybe the tobacco firms will successfully embrace whatever technology emerges to create a safe proxy to smoking.

As for the oil industry — my view is that its future is limited. Until recently, there was a view that while oil as a source of fuel may have a limited life, it will still be required for making plastic. Now we know that plastic pollution poses a threat to humanity too.

No, I would argue that oil poses an existential threat to humanity, and that is bad news for the oil industry (and not particularly good for humanity). For investors, the opportunity lies with oil substitutes — such as renewable energies and whatever less damaging technology, such as CRISPR/cas 9, can come up with as an alternative to plastic.

The oil companies may be able to shift with the new technologies, although I suspect they're too wedded to their traditional product to successfully make that jump.

Applying an ESG strategy, I would say climate change must be a major consideration.

The ‘G’ bit in ESG applies to governance, and that takes me to privacy, the EU’s privacy regulation, GDPR and Facebook.

A number of privacy experts argue that regulations such as GDPR merely enforce upon companies the adherence to good practice that, for sound commercial reasons, they should be applying anyway.

The argument continues: trust is the currency of success, a business that isn’t trusted by customers is one that has no future. And that as we approach the third decade of the third millennium, privacy aware customers expect their privacy to be respected.

I have some ironies for you.

Irony number one, the US government has been a massive critic of GDPR, which it describes as a protectionist policy, yet it is the US, not the EU applying GDPR, that has fined Facebook a massive $5 billion for its role in the Cambridge Analytica saga.

Irony number two, despite the fine dished out to Facebook, it is the US government, more even than China, that poses a threat to our human right to privacy here in Europe. It is trying to enforce the likes of WhatsApp to put back doors in its product, such that its intelligence agencies can spy on us. Such a move wound be a horrendous error, there is no such thing as a back door that only intelligence agencies can access. Once it is created, criminals will learn how to access it, and our lives will be like open books to any criminal gang or terrorist organisation that wants to know about us. Companies may apply good governance but they must follow the law, which is in danger of representing the opposite of what ESG is supposed to represent.

Irony three: the Facebook share price climbed to an all time high some time after the Cambridge Analytica breach, and was close to that level after the fine was announced. The story of the Facebook share price, just like that story of the tobacco firms, might suggest that ESG issues and share price performance are not related. On the other hand, who knows how the shares will perform in the future, and in any case, maybe without the Cambridge Analytica breach, Facebook shares would be much higher.

Facebook is trying to present the veneer of a chastened company, Nick ‘the Saint’ Clegg, its PR man, gleaming under a halo. It has even changed the name of WhatsApp and Instagram to WhatsApp from Facebook and Instagram from Facebook, and St Clegg has blessed Mark Zuckerberg under an Apple tree, while he was at it.

Meanwhile, Apple tries to make its approach to privacy a unique selling point, ‘we believe that privacy is a human right,’ suggests Apple’s privacy policy.

But in the third decade of the third millennium, ESG will have a broader application — if there is any sense, it will be a no brainer. Investing in companies with an ethical approach to climate change, plastic pollution and maybe the threat of insect extinction will be a no brainer.

But if we are not careful we are in danger of heading for a kind of dystopia, the ethical. social and governance issue of the fourth industrial revolutions are privacy, cyber security, and an ethical approach to data and AI.

The danger with data is not just our privacy, but we also know that data can create racist and bigoted AI algorithms. The tragic consequences of the Boeing 737 Max reliance on software, shows how we need an off-switch and how the ability to override the machine will be an essential governance, ethical and social priority in the 2020s.

These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

Michael Baxter portrait photo
Michael Baxter

Economics Commentator

Michael is an economics, investment and technology writer, known for his entertaining style. He has previously been a full-time investor, founder of a technology company which was floated on the NASDAQ, and a director of a PR company specialising in IT.

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