As its popularity continues to grow, some professional investors are warning that ESG (Environmental, Social and Governance) investing could be inflationary. Their argument is predicated on the expectation that complying with an expanding set of socially conscious mandates may be a worthy goal, but one that flies in the face of Milton Friedman’s dictum that the only raison d’etre for corporations was to maximize profits for shareholders.
It’s perfectly understandable that investors will want to avoid companies reliant on child labor in foreign countries and with toxic environmental practices. But changing corporate behavior comes with a cost.
In the race to satisfy emerging investor demands, is the financial services industry transparent about the ramification? Rob Almeida, chief market strategist at MFS Investments, thinks not.
“Our industry isn’t telling the ESG story properly,” he argues. “I think it is inflationary, as owners of capital are shining a light on stakeholders.”
Almeida’s issue isn’t with well-intentioned investing principles. It’s with disclosure and transparency, two core ESG principles which some practitioners themselves may be violating.
“You are seeing a material change in corporate behavior,” he says. “How does that flow through to the income statement?” The real question for investors may lie in an individual companies’ ability to raise prices.
Then there is the issue of ESG’s value proposition and truth-in-labeling. A number of hot-selling ETFs in the ESG space have been overweighted with what else—Amazon, Alphabet, Facebook and Microsoft.
Lori Keith, co-manager of the Parnassus Mid Cap Fund, acknowledges examining the inflationary aspects of ESG investing is a reasonable endeavor. “Certain aspects of the economy will be prone to increasing costs,” she says. “We tend to look at high-quality companies that are growing with wide moats.”
Among other things, she looks for companies “willing to pay a fair wage” and invest in the workforce. “Companies that underinvested in the work force may be challenged and see higher costs,” she argues.
This doesn’t mean the businesses have to be in the cleanest, greenest segments of the economy. For example, Republic Services, a waste management concern that Keith’s fund owns, has focused on worker safety for years and “has very specific goals” regarding its employees.
“Doing ESG the right way should [ultimately] lower expenses, improve culture and employee engagement and reduce training costs,” she says. “A lot of it has to do with how proactive a company is.”
More consumers have indicated they will pay more to be good citizens. “Sixty to 70% of consumers are willing to pay more for a company that uses sustainable packaging,” she says.
What do the growing expectations of rising inflation mean for the investing environment in general and the ESG universe in particular? “How much inflation is structural?” Keith asks. “It’s not clear.”
Most of the problem is ubiquitous. “No company is immune,” she says. “At some point, supply chains [disrupted by the pandemic] will work themselves out. ESG investors need to find companies managing their supply chains effectively.”
What is Keith’s take on an overall stock market in which many ESG shares have flourished? “We are concerned that valuations have moved higher,” she says. “Much of the recovery is priced in.”
However, she believes high-quality companies that don’t rely on the economy will benefit in the long run. The prices of some companies at the epicenter of the pandemic are cause for caution.
Shares of Live Nation are “trading higher than they were pre-pandemic,” she notes. So far, nobody has been going to concerts.