Response to 'The fallacy of ESG investing' on FT.com

Ian Nolan’s response to Robert Armstrong’s (US Financial Editor) Financial Times article, ‘The fallacy of ESG investing’ published on October 23rd 2020.

“Win-win arguments promoting both bigger profits and better social returns are illogical”, argues Robert Armstrong, in a recent article questioning the long-term performance of ESG strategies (Ft.com, The fallacy of ESG investing, October 23rd).

While Mr Armstrong may be right to challenge the simple appeal of ESG investment – “doing well by doing good” – it is merely a straw man that he demolishes. His claim that ESG is, at best, only a ‘factor’ similar to size, momentum or growth, simply doesn't stand up to rigorous scrutiny.

We are all increasingly realising that much of today's economic activity produces negative externalities, contributing to climate change, loss of biodiversity and general diminution of the natural capital endowment that our generation collectively inherited from our parents, and which we in turn will pass on to our children’s generation.

I would argue that there is a secular trend for governments to act – albeit belatedly – to force companies to internalise some of these costs, through taxes, mandates or regulation. These trends should not be confused with the cyclical fashion (or otherwise) of investment factors. Being on the wrong side of such a trend risks being a very expensive investment mistake to make, as they create inflexion points in value which fashion will not reverse.

Mr Armstrong justifiably raises numerous other challenges to the validity of the somewhat naïve ‘doing well by doing good’ thesis. Trying to take a more socially responsible view than your competitors is unlikely to be good for profits, unless you have developed a product/solution which is faster/cheaper as well as more sustainable.

This said, there are companies whose innovations meet these criteria precisely. What’s more, their premium value is being widely recognised across the financial markets. Conversely, those with the inability to do so become ever-more vulnerable, as society becomes less tolerant of businesses which privatise their profits while socialising their costs.

These are hard questions for investors to answer, but expensive if they get them wrong.

Ian Nolan, Partner, Circularity Capital LLP