The Markets Won’t Solve This

But they will keep selling you products promising that they will.

Have I got an investment opportunity for you!

Photo by Kace Rodriguez on Unsplash

I spent the last 20+ years of my career in the finance industry. I was never a Wall Street highflyer and I never aspired to be. But I do know what is going on. For most of that career, I focused on sustainable investing and incorporating environmental, social, and governance (ESG) factors into the investment process when they were applicable to an investment.

Including ESG in the investment process just makes logical sense. Some companies are going to have environmental, social, or governance issues that are important (the financial world term is material) enough for investors to want to know about them. Environmental issues can be, but aren’t limited to things like addressing climate change, or water use. Social issues might include health and safety records or employee turnover. Governance analysis tries to evaluate whether the board of directors has a proper check on management power and whether shareholders have proper rights.  

This all sounds like a good idea, which is what attracted me to this corner of finance. I was fighting the good fight to make sure companies acted responsibly and that shareholders had all the information they needed to make informed decisions.

But something happened to ESG and sustainable investment along the way.

It got popular.

How popular? Follow the money.  

Global investment funds that call themselves ESG or sustainable investment funds grew to about $650 billion in assets under management in 2021. This number was only about $275 billion in 2020.

Like many big numbers that get thrown around about finance, there is much smoke and many mirrors at work here.

Over the years, people have noticed climate change and the environmental degradation of our world. In many cases, they wanted to do something about it, or at least they wouldn’t have minded if their mutual fund told them they were doing something about it.

At the same time, integrating ESG in the investment process has gained steam since the Principles for Responsible Investment (PRI) was founded in 2006. The aim of PRI was to get investors to better evaluate material ESG data in the investment process so that they can understand the whole story of the companies in which they invest.

As of the end of 2021, the assets under management for the many global signatories to the PRI were about $121 trillion. To put that in perspective, that was more than the global GDP in 2021, which was only about $97 trillion.

Global asset managers who say they are investing in a sustainable way or under ESG principles were at about $121 trillion. There is only one problem. What these funds say is reality and what is really reality are two very different things.

I can say that I won the Oscar for Best Actor last year and pitched a no-hitter in the clinching game of the World Series to bring the World Series trophy home to Cleveland for the first time since 1948. I’m going to give you a little time to pause here and do a quick search to check on the veracity of my claims.

Those who talk the talk often don’t walk the walk.

Investment firms are full of very smart people. They understand a trend when they see it. ESG funds and funds that claim to invest sustainably have grown in popularity since the PRI was formed in 2006. Some of this comes from investors doing the work of incorporating ESG factors into the investment process, but some of it also comes from investors wanting to make a difference with their investments.

Investment firms were quick to notice that investors who wanted to invest sustainably would pay higher fees for the privilege of saving the planet with their investments. Some investors were happy to pay higher fees if they could say that their investments were having a positive impact.

When a company, investment firm, or anyone overhypes the “greenness” of their activity, it is called “greenwashing”, and greenwashing in the investment industry is rampant.

A recent report from RepRisk showed that greenwashing by banks and financial services companies around the world rose 70% in the past 12 months. European financial institutions accounted for most of this greenwashing, with most of the greenwashing involving claims about fossil fuels.

An academic report from March of this year found that only 5% of investment funds labeled “sustainable” align with Paris 1.5C goals.

To be fair, not all ESG funds need to align with the Paris goals of keeping global warming to within 1.5C. But that 5% number is incredibly low. If investors were getting investment vehicles that truly aimed to be sustainable, that 5% number would be much higher. In a world where 70% of financial firms engage in greenwashing, investors generally have no idea how “green” their investments are or are not.

I could start a fund tomorrow that seeks out companies that use child slave labor to club endangered animals and then burn those endangered animals for energy.

I could call it the Children's Endangered Wildlife Energy Fund.

Young investor reading the prospectus for the “Children’s Endangered Wildlife Energy Fund.”

Photo by Elisa Ventur on Unsplash

Finance won’t save you. You have to save yourself.

Investors are starting to catch on to the con. Net inflows of money into ESG mutual funds and exchange-traded funds went down 76% to $157.3 billion in 2022 from $650 billion in 2021, according to Morningstar data.

Regulatory authorities are starting to catch on. The European Securities and Markets Authority (ESMA) just put out a paper examining some of the greenwashing that is taking place in Europe. In the United States, the Securities and Exchange Commission (SEC) just toughened up its “Name Rule” to require funds with ESG or sustainability in their titles to have at least 80% of assets support such claims.

These are just two of the positive steps regulators are taking.

You can call finance evil or cynical all you want, but finance was only filling a void that our political leadership has refused to fill. People wanted some kind of action on sustainability issues like climate change, and some people in the financial world raised their hands to offer a solution. They were only able to profit from greenwashed products because our political leadership wasn’t offering any solutions.

Climate change and our other environmental problems won’t be solved solely by investments in clean energy or in substitutes for plastic. Those things will help, but investment alone won’t solve this. Investment is reactive to a political, legal, and cultural landscape. Policy, in the form of laws and rules, will play a much larger role in what we do and don’t do about our crumbling environment.

People can say “government is the problem” all they want, but leadership in government can solve these problems to a greater extent than any other actor in this game. Investors and companies react to the environment they find themselves in. Yes, they try to influence the government, but a government ultimately sets the rules of the game. About 30% of the world has a price on carbon today. As a result, we are where we are in the fight against climate change. If 90 percent of the world had a price on carbon, and that price was high enough to be meaningful, we would have a very different world. Investors can’t do that. Companies can’t do that. Governments can.

Without government investment, the internet would not exist, and Substack wouldn’t exist. You wouldn’t be reading this right now.

But government is the ultimate short-term game, and climate change and other dire environmental issues are long-term problems. Until they are not. We are now at the point where they are not.

If we want to tackle climate change, ocean acidification, plastic pollution, and myriad other environmental disasters, we must partner with governments. We must tell them clearly that action on these issues is what we want. We want subsidies for programs beneficial to the survival of humankind, and no subsidies for those activities that destroy humankind. We want them to act with incentives and rules that help us save ourselves.

If governments can pass laws that require us to wear our seatbelts, require us to have insurance, require us to send our children to school, and require us to do hundreds of other things that are good for society, we should ask them to require us to save ourselves.

If you are not into that, I’ll start working on the prospectus for the Children's Endangered Wildlife Energy Fund.