Has ESG become too focused on climate? For some investors, nothing matters more. But the energy put into lobbying listed companies may simply give the illusion of control; worthy work rather than actually changing much. There is little agreement on whether avoiding shares in a “bad” company by itself actually sends much of a signal. Do well capitalised, cash generative companies actually care about who is missing from their shareholder register?
Today’s pre-occupation with carbon risks drawing attention away from governance. This was core investment work long before ESG or even socially responsible investing. Companies that back-up their business strategy with sound stewardship driven by the board usually win over the long term. But it is less prescriptive work – more about judgement and engagement – so harder to tick the boxes that regulators like. There is plenty of evidence that governance is taking a back seat now – other, that is, than the diversity targets. How many more examples like THG, previously The Hut Group, are needed before the stockmarket seriously tackles weak boards and perverse incentives?
The challenge for investors is that environmental issues are the stuff of headlines. Environmental concern carries a halo effect that can override common-sense. Investor activity on carbon lends itself to box ticking, prescription and conformity in approach. In this polarised world, there is little genuine debate. No-one disagrees with sustainability, but the UK’s national resilience has clearly been hit by its much faster move on carbon - allowing us to lecture other nations, but wrecking consumer markets for green energy as successive suppliers fail.
Human thinking is challenged by ambiguity, yet we live in a complex world with shades of grey. Expecting too much of investors for problems that society as a whole owns, is an approach likely to fail. Good practice does not come from narrow focus, stopping little to assess impact and revise. Effective work on stewardship is time consuming and involves a two-way flow of information.
Governance may offer more certain rewards. Executive incentivisation, board leadership, and a record of long term stewardship of capital and stakeholder interests are all closely linked with business strategy. This is the area that investors best understand. Good governance is the part of stewardship that plays to investors’ strengths and where they are most credible, even if not currently fashionable. When companies prosper in a world of easy money, there is much less concern on bad practice. It is hard to imagine in normal circumstances, that some of this year’s IPOs would be accepted by investors, with so little discipline on chief executives.
With so much emotion wrapped-up in climate and carbon, the economic message from the oil price might be missed. The soaring oil price could have much further to go, challenging the will of policymakers to rein-in stimulation. Central banks see the oil price squeeze as disinflationary in the medium and longer term, reducing the need for interest rate rises. In previous cycles, it has been the bond market that brought discipline to central banks, with a yield curve flattening often heralding recession. But this time round economic pressure may come from the oil price itself. Superficially that seems to combine the job of interest rate rises and a carbon tax, but in the US at least, the consequences are likely to be politically unpalatable. The sensitivity of politicians to the pain of transition may undermine much of what investors would like to do.
All parts of ESG matter; a joined-up approach is needed. Investors should recognise that good governance can pay off and makes sense irrespective of regulation. Dealing with carbon should involve governments and consumers as much as investors. Shaping companies as good corporate citizens might be best achieved by investors getting the governance equation right and building good stewardship into company boards.
A version of this article was published in Citywire on 18.11.2021.