Thursday, June 3, 2021

Proxies

A correspondent asked for comment on the new ESG trend among asset managers. For example, BlackRock, and the recent Exxon upheaval with two new green directors (here, but cautionary WSJ coverage here, pointing out how empty the whole Exxon affair really is).  I'm sad to see even Vanguard (which has a lot of my money) going along on this...trend. 

Could you offer some thoughts about the trend of asset managers voting more critically this year? Are the big fund firms like BlackRock getting too far removed from the wishes of their customers? Other analysts say that BlackRock and other ESG-minded fund firms are only following the wishes of their younger investors who care more about those themes, maybe that makes it all ok?

My answer: 

As a private property fan, if the owners of a company want to spend its money on pointless virtue signaling, or important but unprofitable save-the-planet and cure-racial-injustice initiatives (depending on your point of view),  that’s up to them. I would rather get rid of the whole corrupt non-profit status anyway and see lots of organizations organized as corporations devoted to causes right and left. 

The issue here is representation. A very small minority is making these decisions on the behalf of a large and unrepresented majority. For example, if you have a company 401(k) managed by a plan, invested in a mutual fund, who hires out their proxy voting to a service, the decision to trade money for social good, and just what constitutes social good, is a long way removed from your preferences. (Me and Vanguard, for example.) 

I think the central problem is that our corporate governance system is stuck thinking of a world of fairly large individual investors who take an active interest in corporate affairs. There are regulations, for example the fiduciary rule that says intermediaries are not supposed to do anything but guard your money. But those are clearly not working, and rules can never provide a good outcome anyway. 

I think the world might be better of with more non-voting shares. Mutual funds and asset managers could hold non-voting shares, so certify that they will not inject their preferences along the way.  People who don’t want to think about proxies can do the same.

As an economist, I always look first to see what's wrong in the rules of the game if I don't like the outcome. 



14 comments:

  1. Outside of Black Rock, I had a bit of trouble finding out what large index providers voted for the Engine No. 1 slate (or didn't). I haven't seen any index providers changing their marketing strategy to take advantage of the big players going the other direction.

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  2. John,

    "A very small minority is making these decisions on the behalf of a large and unrepresented majority...I think the world might be better of with more non-voting shares."

    If under respresentation is the problem, then how is reducing representation through fewer voting shares the solution?

    If anything, a company should only sell voting shares. If you don't like the way a mutual fund (for instance Vanguard)is voting your shares, fine, dump your mutual fund and buy your shares directly.

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  3. "There are regulations, for example the fiduciary rule that says intermediaries are not supposed to do anything but guard your money. But those are clearly not working, AND RULES CAN NEVER PROVIDE A GOOD OUTCOME ANYWAY."

    Your Standford compatriot John Taylor would disagree (see Taylor rule).

    "I think the world might be better of with more non-voting shares. Mutual funds and asset managers could hold non-voting shares"

    And what stops mutual fund and asset managers from purchasing voting shares if not a rule? Or should all shares be non-voting shares?

    "As an economist, I always look first to see what's wrong in the rules of the game if I don't like the outcome."

    Rule #1 of the game are, if you don't like the way your money is being voted, park your money somewhere else.

    Now, if you are like me that would suffer an early withdraw penalty for moving money out of a retirement fund to purchase individual shares, that is a rule that is certainly worth discussing.

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  4. What do you mean by "rules can never provide a good outcome anyway"?

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  5. John,

    "A very small minority is making these decisions on the behalf of a large and unrepresented majority."

    Henry Kissinger cracked the problem of small minorities over 50 years ago.

    https://en.wikipedia.org/wiki/Triangular_diplomacy

    Were you not paying attention?

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  6. John,

    "As an economist, I always look first to see what's wrong in the rules of the game if I don't like the outcome."

    Okay, here is a game I think you can understand - Wild West showdown.

    In the two player version of the game, each person has a gun and a single bullet. Man who shoots first (quickest draw) always wins.

    In the three player version of the game, each person has a gun and a single bullet. Man who shoots first (quickest draw) always loses.

    Notice, both games have the same rules, but adding a third player to the game vastly affects the incentives of all players involved.

    Economics isn't about rules (per se), it is about incentives - and you should know this.

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  7. This is a fascinating variation of an older truism, and that is that shareholders of public companies are (usually) unorganized and scattered (and further diluted through owning shares through ETFs and mutual funds), while management is tight and cohesive, and has a monopoly on some types of information.

    Of course, one can incentive-ize management through share options. But one might ponder if management is so well set-up that there is a "backward-bending" supply curve. As in, "I am making several million a year as a public-company manager anyway. I can virtue-signal with my public company, become influential in Washington, and get a sexy new girlfriend. The shareholders will accept lower returns."

    It is notable that there is about a 25% premium to take a company private.

    Of course, there are exceptions, and some people buy shares that way, as in hopping on board a public company into which a new and large shareholder just made a buy, and who might make management beckon.

    Interesting topic.

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  8. As someone who works in asset management, albeit in Europe, I think you would be surprised by how much end demand there is from customers for ESG products. And, importantly, customers who value ESG are much louder than those who are anti-ESG. It strikes me as being similar to how/why so many products are Kosher.

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  9. A bit of an aside, but I've never understood the calls for oil companies like Exxon to get into renewables. Exxon's unique capabilities are (1) employing the world's best geologists, and (2) successfully navigating difficult geopolitical situations. I'm not sure how either of those things translate into being good at building solar panels or wind farms or growing algae or whatever else it is that progressives want Exxon to be doing?

    I would have thought those concerned about climate change would be pursuing something more along the lines of "stop making huge capital investments in new oil wells, and divert those funds towards mining the minerals that will be required to power the green revolution." That'd leverage Exxon's unique capabilities and move us closer a green future. But that doesn't seem to be the ask. Exxon now has several directors with experience in wind power specifically (implying that's the new direction), and Shell is being told they must produce renewables.

    I'm sure there's some answer to this, but man, it's just another example of how perplexing I find the results of modern populism.

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    Replies
    1. Presenting itself as a renewable energy company rather than (just) an oil company might deflect hostile regulation and other punitive legislation. Especially in the presence of unbridled activist government, bad PR is bad business.

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  10. If the environmental stuff is a small share of capital markets, the effect of buying this stuff on rates of return is zero. If the share were sufficiently large, the rate of return on environmental stuff would fall.

    Sounds fair. :-)

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  11. Perhaps a look through the literature might turn up some nuggets of interest.

    From RBC-Global-Asset-Management:
    "Does socially responsible investing hurt investment returns?", © RBC Global Asset Management Inc. 2019.
    https://www.rbcgam.com/documents/en/articles/does-socially-responsible-investing-hurt-investment-returns.pdf

    Quotations from the section headed "Summary and Conclusion",

    1) "The chief finding of this research [for this report] is that socially responsible investing does not result in lower investment returns."

    2) "While the updated version of this paper reaffirms that socially responsible investment does not necessarily result in lower investment returns, the question of whether socially responsible investment strategies outperform traditional investment strategies remains inconclusive."

    3) "Some opponents of SRI refuse to acknowledge that anything other than financial factors can potentially affect the value of a security. Conversely, some proponents of SRI are so attached to their morality and personal beliefs that they cannot fathom that incorporating these beliefs and values does not have a beneficial effect on investment returns."

    From Standard & Poor's we learn:
    "ESG funds beat out S&P 500 in 1st year of COVID-19; how 1 fund shot to the top."--S&P Global Market Intelligence, 6 April 2021.
    Quotations:
    1) "In the first 12 months of the COVID-19 pandemic, many large investment funds with environmental, social and governance criteria outperformed the broader market. One fund went from being among the poorest performers to the top of the list following tweaks to its portfolio."

    2) "The creation of sustainable index investments has enabled a massive acceleration of capital towards companies better prepared to address climate risk," [Larry] Fink wrote. "As more and more investors choose to tilt their investments towards sustainability-focused companies, the tectonic shift we are seeing will accelerate further. And because this will have such a dramatic impact on how capital is allocated, every management team and board will need to consider how this will impact their company's stock."

    3) "The 26 ESG funds in our analysis all saw their performance improve in the first 12 months of the pandemic, although to varying degrees. One ETF — SPDR S&P 500 Fossil Fuel Reserves Free ETF managed by a unit of State Street Global Advisors Inc. — performed the same as the broader S&P 500. Six funds that underperformed relative to the S&P 500 saw a price increase ranging from 17.7% at the Ave Maria Growth Fund managed by Schwartz Investment Counsel Inc. to a 26% change for the Ariel Appreciation Fund managed by Ariel Investments LLC."
    URL:
    https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/esg-funds-beat-out-s-p-500-in-1st-year-of-covid-19-how-1-fund-shot-to-the-top-63224550

    Of the two publications RBC-GAM comes closest to properly measuring risk/reward; S&P Global Market Intelligence is the weakest at analysis. Neither report having calculated the Sharpe Ratio or the Traynor Index for the funds that they investigated.

    We learn in the S&P Global Intelligence report that the top performing portfolio fund held 28 to 36 names and the fund management style was "value" and the fund manager would double his bets on stocks he liked. The portfolio returned 55% last year from March 5 2020 to March 5 2021, besting S&P 500 in the same period by 27.9 percentage points. No Sharpe Ratio or Traynor Index comparison is reported.

    The ESG appeal is emotional.

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    Replies
    1. Reading the Saturday (June 5/21) edition of the National Post (Toronto) on-line the following quotation from Mark Carney, Ph.D. (former Governor of the Bank of England; former governor of the Bank of Canada):
      ''Carney admits that the “integrated reporting” required by ESG is a morass: “ESG ratings consider hundreds of metrics, with many of them qualitative in nature… Putting values to work is hard work, but as with virtue, it should become easier with sustained practice.” No need to ask whose version of values and virtue is to prevail.''-- Peter Foster, NP.
      [ https://nationalpost.com/opinion/peter-foster-mark-carney-man-of-destiny-arises-to-revolutionize-society-it-wont-be-pleasant ]

      Further along in the same National Post article, Peter Foster quotes Fomer U.S. Undersecretary for Science (U.S. Dept. of Energy) Steven E. Koonin on Mark Carney, Ph.D.,
      '' [S. E.] Koonin notes in his book that Carney “is probably the single most influential figure in driving investors and financial institutions around the world to focus on changes in climate and human influences upon it…. So it’s important to pay close attention to what he says.”''
      [Ibid.]

      P. Foster observes, ``H. L. Mencken observed that “The urge to save humanity is almost always a false-front for the urge to rule.” '' [Ibid.]

      Foster further notes, the ``...classic example of what Friedrich Hayek called the “fatal conceit” of constructivist rationalism: the belief that the largely spontaneous institutions of the market order should be rejected in favour of more deliberately planned arrangements.'' He goes on to express concern over those, ``...that philosopher Karl Popper described as “enemies” of an “open society.” Popper noted that social upheavals tend to bring forth prophets who claim to understand the forces shaping the future, and promise salvation if they are given absolute power.''

      ESG is emerging, in Foster's view, as a basis for radically undermining and overturning the classical liberal market order. Peter Foster closes his article with this observation,

      '' Carney is a man on a mission to change global society. “Business as usual” — the most hated phrase in the socialist lexicon — is “ultimately catastrophic,” he writes. There is too much “misplaced acceptance of the status quo.” But somehow the new socialism will not be socialism as usual. This time it’s different. We can because we must. The threat is too great to permit any argument. It’s surprising that as he was picking out choice quotes from Lenin for his book, Carney missed this one: “No more opposition now, comrades! The time has come to put an end to opposition, to put the lid on it. We have had enough opposition!”''

      ESG is one tool in a kit that seeks to revamp the developed nations' assumptions underpinning the market economy. ''ESG's appeal is emotional'', I wrote above. I can now add, the following qualifying phrase, ''as intended.''

      Delete
  12. “BlackRock and other ESG-minded fund firms are only following the wishes of their younger investors . . . .” That’s not very plausible, since these firms are well aware that the big money is held/invested by old people.

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