On our ongoing theme of the revenge of the real, the most recent edition of The Economist was devoted to a critique of “big ESG” — the use of “environmental, social, and governance” metrics to grade and construct investment portfolios and indexes. It’s not a condemnation — the magazine is generally favorable to the motivation behind ESG, but thinks that it has lost its way in a maze of poor (or outright deceptive) measurement, self-congratulatory posturing by executives and managers, and untoward quasi-regulatory pressure. We are sympathetic to this point of view. We noted also that recent data show the inflow of investment dollars into ESG products and strategies has continued its decline from the pandemic heyday.
Source: Jefferies Equity Research
Fewer ESG funds are launching, and fewer existing funds are being reclassified as ESG. This is perhaps due to the threat of higher regulatory scrutiny on the reclassification process, coming on the heels of fraud and scandal revelations at large institutions in recent months. Perhaps we are witnessing the passing of “peak ESG.”
Of course, inflation also filters in to the minds of company and fund managers as well as regulators, financial authorities, and political functionaries. Fed Chair Powell today said (humorously, in our view, given the near perfection of the Fed’s failure to correctly model the current inflationary debacle), “We have both the tools we need and the resolve it will take to restore price stability on behalf of American families and businesses.” But this is conceit, hubris, or grandstanding. Officials are not highly skilled pilots and navigators carefully making minute adjustments to precisely nudge the path of an airplane towards a safe landing. They are dealing with a vast, recalcitrant, opaque system whose real functioning is apparently quite different from the billion-dollar doctrinaire modeling which led them to err so drastically on the inflation question and bring us to the current state of affairs.
Further, as we have noted before in the context of our ongoing series covering “necessities,” the Fed can have only the most distant and tenuous influence on the production of oil… natural gas… fertilizer… or food (or indeed, willing workers). However, these “volatile” items, edited out of metrics like “core CPI,” and which have driven the Guild Basic Needs Index higher, are all items whose supply has been deeply affected by the political reign of ESG — which has starved vital sectors and industries of capital for expansion, and virtually engineered the supply side issues over which the Fed is powerless.
If “peak ESG” is indeed occurring — and we wouldn’t want to call that prematurely; we’re just looking at the possibility — that would imply long-term structural upside for the sectors and industries that have been excluded from it, because the valuations of many companies have been suppressed by non-economic, political factors which have led to impaired demand for their equity and debt — and which may now be starting to recede.
Investment implications: Commodities are volatile. Recession will hurt them. However, we believe that the theme of the “revenge of the real” will be a lasting one, and that the pressure of real needs and insufficient supply, unaddressable by monetary and fiscal legerdemain, could lead to a structurally favorable period for “orphan” assets pushed aside by the wake of the ESG dreadnought. We are attentive to those orphan assets as a central point of interest in coming years.
