The Secret Diary of a ‘Sustainable Investor’ — Part 2
By Tariq Fancy
August 2021
This is the second of a three-part essay that shares how my thinking evolved from evangelizing ‘sustainable investing’ for the world’s largest investment firm to decrying it as a dangerous placebo that harms the public interest. It’s not short. But this topic is critically important: it lies at the heart of how we reform capitalism to address important environmental and social challenges with concrete action. I challenge business leaders who have advocated the ideas I question below to offer a serious rebuttal.
We’re running out of time: we can no longer afford to answer inconvenient truths with convenient fantasies.
JUNE 2022 UPDATE: TEN MONTHS AFTER PUBLISHING THIS THREE-PART ESSAY, I ADDED A FOURTH AND FINAL CHAPTER HERE
“[Tariq Fancy]’s confessional essay… is riveting.” — The Economist
“…full of powerful and darkly funny anecdotes about high finance.” — Financial Times
“[Tariq Fancy] more or less went nuclear, declaring the whole industry not just fuzzy and vague, but actively destructive.” — Fortune
“Masterful job… it’s long but worth every minute of your attention.” — The Dude
The Secret Diary of a Sustainable Investor
I. How the System Works
II. Why we can’t rely on ‘good sportsmanship’
III. The Danger of Fairy Tales
IV. Epilogue: The Hero We Deserve (New: June 2022)
A PDF version of the original three-part essay is available at this link. A PDF version of the epilogue is available at this link.
II. Why we can’t rely on ‘good sportsmanship’
Trying to figure out whether a company’s good environmental and social deeds actually translates into financial profits is a bit like trying to figure out how much purpose and profits truly overlap, which is a bit like trying to figure out if a morning coffee is healthy or not: the more work you do, the more confused you end up. I began really digging into the research when we were looking to hire a head of ESG research. The fundamental question is around whether or not better ESG performance creates better shareholder returns, which is the finance industry’s jargony way of asking whether being a responsible and good corporate citizen truly helps profits or not. Does good sportsmanship actually help basketball players score more points?
Some say that ESG helps profits, some say it doesn’t, and while for many researchers the views often seem predictably aligned with their existing political preferences, financial firms seem mostly in a race against one another to declare that ESG, like anything with the word sustainability in it, is good for business. Of course we’re doing it, everyone is! Adding to the general sense of confusion, for the most part they compare financial performance to widely varying measurements of environmental and social performance. Often, everything ranging from levels of greenhouse gas emissions to supply chain labor standards and the diversity of the board of directors is mashed into a single “ESG score” for a company, which serves as a quick and convenient measure of corporate virtue.
I met Inessa Liskovich when she interviewed for our open research role. A Princeton and MIT-trained economist, she had studied ESG and was looking to leave academia. Besides being super smart — both analytical and quantitative yet also right-brained enough to know the right questions to ask of the data — she was also refreshingly candid, highlighting the uncertainties and conflicting theories in the space. As we chatted it started to become clear to me why studying ESG was becoming so popular at universities: many researchers are personally willing to spend money and invest in companies that are responsible, so they want to think about how it scales up more broadly and what it means for the market. Since you generally can’t publish a “null” in academia — a conclusion that there’s no real connection between causes and effects being studied — this meant more researchers with an incentive to find something, meaning for the most part highlighting specific, small ways that ESG may be good for long-term profits. The motivations were pure: to encourage businesses to be more responsible.
Still, Inessa gave a sober and honest analysis about whether ESG and ‘being responsible’ really generated investment profits. “Does it actually make returns higher? Unclear — totally unclear.” She floated the idea of it being what economists call a luxury good: “Something that does really well when people have money, and they love to spend on it because it makes them feel good, but it kind of goes away a little bit when there’s less.” In the end, she didn’t really come out strongly for or against: “I think that there are a lot of unknowns in the space. It’s super, super young.”
Unfortunately, ESG data was also generally unreliable and the ratings were everywhere. A Wall Street Journal headline at the time pointed out that whether Tesla or Exxon Mobil is more sustainable “depends on whom you ask.” To help sift through the data issues, many academics offered their services to us. And why not? There was money available from the private sector to jointly study sustainability issues. I can’t remember seeing any such studies that were not pro-ESG. The story was always the same: that being a good corporate citizen was good for business, so obviously a no brainer in this new era of “social purpose.” After reading a few pro-ESG papers whose methods and conclusions I found rather dubious, something occurred to me: there’s always money to be made from telling people what they want to hear.
It was also interesting to see more grizzled, veteran investors whose principles I had learned and applied earlier in my career express far less enthusiasm for sustainable investing. Warren Buffett is famously skeptical about ESG, saying last year that companies should prioritize shareholder value over social causes, and pushing back against pro-ESG shareholder resolutions at Berkshire Hathaway’s annual meeting this year. My work in technology with Rumie had brought me closer to the musings of Marc Andreessen, the famous technology entrepreneur and investor, whose impressively egg-shaped head produces many thoughtful musings, one of which was apparently that impact investing “is like a houseboat — not a very good house, not a very good boat.” It’s unlikely they’re greedy or blindly pro-business. Andreesen and his wife are active in philanthropy and Buffett has pledged to give away over 99% of his wealth. In fact, in 2011 Buffett wrote an op-ed demanding the government raise his taxes entitled “Stop Coddling the Super Rich.” Even so, he didn’t seem to be on this newly fashionable “good sportsmanship leads to profits!” bandwagon.
The marketing and sales people at BlackRock were all about ESG — they couldn’t get enough of it. The portfolio managers were often the opposite: many of them wanted to pass the “ESG test” and be left alone. In one chat with a portfolio manager of stocks, I noticed that his subtle dismissal of the latest research declaring ESG-data-is a-godsend! had a “thou doth protest too much” air to it. It wasn’t hard to guess why: besides a few specific areas such as risk, they generally didn’t have other parts of the firm politely insisting that they please consider this important data set they hadn’t considered all that much before. The portfolio manager’s view was that they’re already focused on performance since it usually determines their compensation, so if ESG information was truly useful they’d use it without being asked. As a result, the internal dynamics at BlackRock felt a bit like sports agent Jerry Maguire telling himself and others that good sportsmanship is important; and then the part of his brain that actually makes the decisions on who to invest in and put on the court focusing almost entirely on who scores the most points and wins the most games.
Sustainable investing, minus the investing
According to Wikipedia, Benjamin Yeoh is a British Chinese playwright. His play Yellow Gentleman, which was his third work to premier in London, received four stars from Time Out: “Yeoh’s account of the immigrant experience of Tommy’s journey from Malaysia and his acceptance into the social whirl of the 1960s is cleverly played off against the generational conflict.” According to LinkedIn, however, Benjamin Yeoh is a Senior PM at RBC Global Asset Management in London. They’re both the same person, though fortunately his less interesting day job doesn’t pollute the extracurricular exploits that form the basis of his Wikipedia entry. “We manage global equities in an ‘integrated ESG’ fashion, or whatever you want to call it,” he told me when we first met in London. “This is a set of complicated sustainability trade-offs.”
I found him almost by accident: after meeting Inessa and reviewing the research, I started developing a thesis that stale accounting standards were obscuring the value of ESG to profits. Through a Google search, I landed on Ben’s blog. It seemed that he was the only other person thinking about ESG the same way as me. My unsolicited email to him resulted in a lunch meeting at a fancy Peruvian restaurant steps from our European headquarters near Bank station in London. “ESG screening is probably going to remain a minority sport,” he remarked as the server put down plate after plate, having advised us clueless non-regulars down a path that unsurprisingly involved ordering enough to feed us for days.
“Whether structured or unstructured, you could call it another data set.” His thoughtful, measured approach contrasted considerably with much of the cheerleading. Hearing about ESG as “another data set” was somehow less exhilarating than I was used to hearing. But what about the purpose? He finished with an anecdote that caught my attention. At a high-profile responsible investing conference a few years ago, he was on a panel on ESG investing and happened to ask the audience a question: “How many of you have actually made a professional investment?” No reaction. He piped in again. “I mean, as in, has anyone here ever made a purchase of shares on behalf of a client? For a few million dollars at least?” Nothing. No hands from his co-panelists. Nor the audience. He was the only one in a room of around one hundred people. It was like a software developer at an ‘ethical programming’ conference suddenly realizing that no one else in the entire auditorium had ever written a line of code before. “On the panels and in the policy area, there are few investors. In the early days, many ended up in the area by accident rather than by design and while not investment trained, saw it was growing fast and had a feel-good factor, and decided to stay. But they’re not investors or much interested in that, and they’re sometimes not really motivated that much by values either.”
I met Ben half a year into my tenure at BlackRock, just as I was really beginning to discover the difficulty of my task. Most of what the ESG cheerleaders wanted to believe should matter for portfolio managers did not matter in reality. It was no one’s fault: the reality is that much of what matters to society simply doesn’t affect the returns of a particular investment strategy. Often this is because of the timeline of the underlying investment: many strategies have a very short time horizon, meaning that longer-term ESG issues aren’t particularly relevant. Sometimes there are debt strategies that have various insurance and protections, and aren’t concerned with a period beyond the debt’s maturity date anyway. Most often, costly and long-term sustainability-related investments are uncertain and take a while to bear profit potential, assuming there is any. And every so often, it’s hard to even understand what good sportsmanship could possibly mean. How do you evaluate ESG for treasury inflation-protected US Government Bonds, and how does that have concrete value to investing — much less the world?
Like a vulture investor in a kumbaya shop
Quickly parsing the hype surrounding purpose and profit was a bit easier because I learned to invest in the distressed investing field. Distressed investors, also sometimes called “vulture investors” and “gravedancers,” spend lots of time digging through lots of stale and irrelevant information to find hidden value in struggling or bankrupt companies. They also tend to get lied to a lot and see a lot of acrimonious situations, making them rather skeptical by nature. It was a mindset I learned well earlier in my career while at MHR Fund Management, whose founder, my old boss Mark Rachesky, had been billionaire corporate raider Carl Icahn’s CIO in the 1990s.
Distressed investors are generally considered aggressive “activists” in pursuing their goals through legal means, shareholder votes, creditors committees, and pretty much any other tools at their disposal. When I lived in that world we regularly locked horns with our competitors. We were once sued by hedge fund Third Point after it objected to a deal that we made with the management of a company in which we had a controlling interest, arguing it unfairly treated minority shareholders. The day the deal was announced, Third Point’s founder, Dan Loeb, called our office and got a 25-year old receptionist. After ensuring that she had a pad and paper ready to transcribe a message for Rachesky, he slowly spelled out: “Please tell him that the next time you fuck minority shareholders in the ass, use lubrication.”
Prior to joining MHR, I was at the investment bank Credit Suisse, where I first got to know Rachesky and his then right-hand man, Hal Goldstein, a former bankruptcy lawyer who had also worked with Icahn. The banker running the deal allowed me, a lowly analyst, to deal directly with the client — a rarity at the time. Although we had little in common on the surface (I was a single analyst in my 20s, he had six kids and would leave early on Fridays to observe the Sabbath), I got to know Hal well enough that we soon shared inside jokes, including an interest in rap music. In a joke I figured he’d understand based on our last conversation, I once left a clip of a profanity-laden portion of Tupac’s song Hit em Up on his voicemail. I immediately panicked afterward, convinced I had committed the cardinal sin every investment banking analyst from that era knew to diligently avoid — showing impertinence — and was going to be reprimanded, even fired for doing this to, of all people, an important client of the bank. Instead, MHR eventually hired me.
As I toiled desperately to make the investment mechanics of achieving both purpose and profit meet the world’s lofty expectations, I would remember the things that Hal taught me over the years. Investment after investment was the same type of thing: tough scenarios where the rubber was hitting the road and companies had to make difficult decisions. It was like judging if players are clean or not based on what they actually do during the fourth quarter in close games, rather than what they say about the importance of showing good sportsmanship in pre and post-game interviews. I reached out to Hal to see if his instincts remain the same today.
“My dogs are sitting here eating grass. And pissing all over the place.” Reached by Zoom in his backyard, he pointed to a Maltipoo chewing on a bone. “His name is Sparky.” With a careful, lawyerly diction he slowly enunciated the next bit: “He is… difficult… at best.” He paused and reflected a bit more. “But cute.” As he balanced an iPad on his lap, whilst sat beneath a children’s playground that his youngest, who is 17, understandably hasn’t used in years, he paused intermittently to evaluate whether or not the spitting rain of the clouds that had recently appeared overhead were reaching him.
“The mission of the corporation is supposed to be to make money for the shareholders, right?” He got to the point for a reason: the vast majority of large US companies are incorporated in Delaware, which is perceived as shareholder-friendly and where the courts have been clear that a corporation’s reason for existence is to serve shareholders. As Nell Minow writes in the Harvard Law Forum for Corporate Governance, the foundation of capitalism is strict adherence to fiduciary obligation (“the punctilio of an honor the most sensitive,” per Justice Benjamin Cardozo in Meinhard v. Salmon). This adherence to fiduciary obligation “gives credibility to capitalism by addressing the agency cost risk of entrusting money to others.” In addition, shareholders get to vote on who sits on a company’s Board — and thus can hire and fire the CEO and management.
“But don’t forget the business judgment rule,” Hal piped in, responding to his own question. “They’ll be protected for making decisions that cost money but are good for the world as long as they have enough information, legal advice, and a strong rationale.” According to the idea of shareholder primacy, good sportsmanship is okay, but only if it benefits owners. (Who, through our sports agents, demand points.) As an example, a CEO may decide to reduce her company’s carbon footprint, but she can’t do so because it’s “fair” or the “right thing to do”; it has to be justified in terms of shareholder interests. As we dug deeper on this, it became clearer and clearer how constricting this is, and how unlikely it is that “good sportsmanship’ can be defined, measured, and justified often and on a large enough scale to make a major difference on key social issues — ones where neutral or bad sportsmanship wins games.
“Still doesn’t make any sense to me!” Hal eventually blurted out. “Listen, you know it’s a marketing gimmick.” He waited for a response. “You know it. We all know it!”
Importantly, he was not necessarily saying that corporations are lying about their commitments to purpose, but rather that since it had to be neutral to positive for shareholder interests, it had to serve some function of the business and the long-term profit machine. And that function was, most likely, marketing. “The question always remains: are we helping the company? And helping the company could just be marketing helping the company, rather than substantively helping the company. Or substantively helping the world. Is that enough of a reason? I would think the answer is yes. If the CEO says he wants to give money to a fashionable cause, and the marketing people say that it’ll be great for our company’s image, isn’t that all you need as a Director?”
While the business judgment rule gives them space to make decisions that aren’t profitable in the short-term, such as investing in long-term environmental initiatives or raising wages, there’s a limit to how far that will go before the exposure to overstepping vexes even the most socially-minded public company CEO — who anyway is personally incentivized to maximize near-term profits. (Emmanuel Faber, who made sustainability a key pillar of his strategy as CEO of European food giant Danone, learned this the hard way in March, when he was ousted by activist shareholders for a lagging share price.) As Minow points out, capitalism is named after the providers of capital (i.e., the shareholders) for a reason. The business judgment rule gives some room, but not nearly enough to pursue society’s objectives at the speed and in the magnitude required to solve some of our greatest challenges.
Let’s take a step back and summarize where we are. Players have collectively engaged in forms of dirty play for decades because it scores points and wins games. The rules generally haven’t changed: in most such cases dirty play can still help maximize points, and players remain under strict instructions to score points and only partake in good sportsmanship insofar as it contributes to (or doesn’t detract from) the scoreboard. And on top of that they’re exceedingly focused on the short-term (think: today’s game), a time horizon for which few believe that good sportsmanship has much of a link to points.
None of this sounded to me like a good setup for success.
Do purpose and profit really overlap?
Think of purpose and profit as represented by two separate circles in a Venn diagram. Where the circles overlap, it shows areas where doing the right thing is also profitable. Unfortunately, where they don’t overlap most large companies have little concrete interest. I once sat in a small, near two-hour Diversity & Inclusion session for financial executives that was chaired by Ana Botin, Chairman of the nearly $2 trillion Santander Bank and scion of the Botin family that has controlled Spain’s largest bank for generations. There was extraordinary enthusiasm for gender-related issues. “It’s about time that we afforded equal opportunities to women in the industry!” exclaimed one executive, quite rightly. We all nodded our heads. Executives from the other major financial firms were assembled around a beautiful boardroom table on a high floor of Santander’s midtown Manhattan headquarters, and one by one they all chimed in. All in favor of course, and all stressing correctly why it made good business sense. Most were older than me, and seemed to now truly believe what they were saying, unlike what I had heard murmured at the obligatory check-box diversity sessions that were crammed into my investment banking analyst training program twenty years ago.
By the time the fourth person at the table excitedly made the same point in different words — that gender-related diversity issues were now very clearly “good for business” because 50% of the population demanded it and the other 50% had apparently just discovered that they have mothers, sisters, wives, and daughters — something suddenly occurred to me. What about causes that were similarly just but did not happen to also be profitable?
I took part in lots of Diversity & Inclusion (D&I) events and activities at BlackRock. They always included large numbers of younger, junior employees — most of whom, it seemed to me, were motivated to support D&I primarily because they felt it was a symbol of the just and fair society they wished to live in, not because it was profitable. How would they react to the notion that many D&I initiatives they believed in, such as support for the inclusion of marginalized racial minorities, might be de-emphasized if and when they didn’t seem to also be quite as good for business? Are important social imperatives best left to companies to manage if they only care about purpose when it happens to overlap with profits?
It was also becoming clear that the degree of overlap between the purpose and profit circles was less than I had expected, or could possibly justify the widespread hype. As I moved through meetings with senior managers across the firm to explore how ESG data could improve their investment processes, I saw firsthand that for most investment strategies only a few ESG issues concretely mattered. It sometimes depended on the location: having an animal rights controversy is worse if you’re based in California than if you’re based in China. Some things are only important when public attention is squarely focused on them: think of how the #MeToo and #BlackLivesMatter movements have elicited hurried responses from companies acknowledging shortcomings in their D&I efforts. (And a number of commitments that have not been met yet.) The idea of fickle public attention to preserve society’s long-term interests is a prospect that should alarm us all: will voluntarily engaging in good sportsmanship be something we can rely on players to keep doing when the spotlight moves onto other issues and the overlap with profit thus recedes? And is a depressing social media feed rife with constant controversy and boycotts the best way to ensure that companies do the right thing?
Do you really want your banker redesigning society?
“He sounds a bit like Notorious B.I.G.,” I remarked to the Head of Fixed Income. We were in the private area of a restaurant in Tokyo that night, having dinner with our Board of Directors at the end of a long day of meetings and presentations. Softbank’s CEO Masayoshi Son, who was friendly with Larry and our President Rob Kapito, joined us for the dinner. Asked by Larry and Rob to say a few words, he stood in the front of the room and launched into a rambling 45-minute discourse that was shockingly immodest. “Larry was wrong, they’re not above 50%. My returns are above 60%!” he exclaimed, pausing either for effect or because he expected others to laugh politely in response. As he rhapsodized about the supposed returns of his $100 billion Vision Fund and its groundbreaking fundraise (“I told Nikesh on the plane to the Gulf that thirty is not worth the effort — it must be one hundred!”), I looked around the room and reflected on the whole proceedings. Across the table from me was Bill Ford, CEO of Private Equity firm General Atlantic and a BlackRock board member. He had a quizzical look on his face. “Those returns are all unrealized,” he grumbled under his breath, presciently noting that until you’ve sold your investment in WeWork, valuing it at the same level that freewheeling founder Adam Neuman sold it to you at may not be wise.
For my part I was more consumed by two rather different observations, the first narrow and intriguing, the second broad and weighty. First, I was slightly surprised that Son’s rambling remarks had enough braggadocio to compete with the lyrics of Biggie’s One More Chance, even accounting for the fact that Rob had, when introducing him, wryly acknowledged that meeting for drinks before dinner may not have been the best decision. Second and more importantly, I started to reflect on the weight of the things being discussed by this small group of the world’s most powerful people.
Earlier that day, during our board meetings at the gorgeous Shangri-La hotel in Tokyo, we presented our strategy to an impressive group, a snapshot of the Davos elite. Philipp Hildebrand, who served as head of the Central Bank of Switzerland until a scandal surrounding his wife’s conveniently-timed currency trades in 2012 forced him out and into safe hands as Vice Chairman at BlackRock, beamed proudly as we presented our strategy and achievements to date. Hildebrand had put up his hand to serve as senior sponsor for this particular area and was rather taken by the symbolism of what we were doing. “We can show how finance can play a constructive role for society!” gushed the former Central Banker, who had a particular affinity for achievements that he could whisper to French President Emmanuel Macron and a host of other impressive-sounding European grandees.
Left unasked in all of the Board activities in Tokyo was a simple question that I mulled over as Masa Son continued a rap battle against no one in particular on the mic that night: was this where such discussions should be occurring in the first place? The size and scale of our efforts could make a major difference in driving key societal outcomes. But at such a critical time, should such important decisions for democratic societies be left to occur in a private forum like this — with decision-makers whose financial interests may not line up with the long-term public interest?
“There were times that I felt like Thomas Jefferson.” So said Johnson & Johnson CEO Alex Gorsky, who led the drafting of the US Business Roundtable (BRT)’s groundbreaking statement on stakeholder value. It’s easy to understand why he felt that way, given the weight of such lofty words about the future direction of not just business, but indeed society in general. But not enough people have asked a simple question: does it make sense that a CEO should feel like a famous US President? Only one of them is elected by the people, after all, unless by “the people” we somehow mean “voting shareholders of Johnson & Johnson.”
This difference might help explain why the BRT’s social aspirations seem rather far off reality. As Aneesh Raghunandan and Shiva Rajgopal point out in the paper “Do the Socially Responsible Walk the Talk?”, relative to their peers, publicly-listed BRT signatories report higher rates of environmental and labor-related compliance violations, pay more penalties as a result, and spend more on lobbying policymakers. BRT signatories have been lobbying actively in recent years against a price on carbon, the elimination of tax loopholes, and a number of other initiatives designed to fight climate change and rising inequality. And a new report last September confirmed that since the global pandemic began, BRT signatories have proven no better than anyone else in protecting jobs, workplace safety, and labor rights, or doing anything to redress racial inequalities.
None of this should really come as a surprise, especially to the signatories of the BRT’s statement. From top to bottom, from CEO compensation to divisional budgeting and P&L to managerial targets, structures, and incentives, we’ve built private firms from the ground up to do one thing really well: extract profits. The majority of America’s largest companies today were founded after Milton Friedman’s era of shareholder primacy began in 1970, and have thus developed into complex bureaucratic machines that are designed primarily to extract maximum profits for shareholders within the rules of the game. (Think of it like levels of elite training to eventually play in the NBA: they’re trained from their youth to score points, win games, and compete at the highest level.) It turns out that a large, multinational profit-making machine that’s built to do one thing really well operates exactly as we should expect it to.
Between now and 2030, the stakes are so high that we should grant ourselves the right to be skeptical, even downright cynical, since we have to make this work. In light of that, the lazy prevailing attitude — that ongoing discussions around “stakeholder value” are automatically steps in the right direction — seems unwise. Given what we know about how the game is played, and the rate of progress we’ve seen over the last few decades, is it wise of us to spend the next decade treating life-and-death issues as if they’re best left up to vagaries of good sportsmanship alone?
A faster moving curve needs flattening: COVID-19
The Monday following the private jet conversation described at the beginning of this essay, I gave notice that I planned to leave the firm. Officially, my reason for leaving was due to very real family business issues I had to help with following my father-in-law’s passing. Unofficially, I had also privately concluded that there was no point continuing in that role: trying to create real-world social impact through sustainable investing felt like pushing on a string.
Anyway, Rumie’s new free microlearning platform was promising, and provided a viable alternative to social media and its crack-like addiction engine. I knew I could do more for the world by making that freely available than I ever would selling a new ‘green’ story atop the largely unchanged economic system that had led us into this crisis in the first place. So I returned to my hometown, Toronto, just months before the COVID-19 global sucker punch landed.
My daily escape from sudden confinement at home came thanks to Ruff, a mixed Border Collie, German Shepherd and Siberian Husky mix who we adopted as a rescue puppy five years earlier. He demanded long and regular walks, which I happily obliged for my own sanity. Even before lockdowns, seeing his goofy, smiling face as he trotted excitedly down the street toward the park had a contagious effect on me and most passers-by. And fortunately, it was quite safe: most folks at that point observed the rules around social distancing, in part because Toronto had suffered a major SARS outbreak 17 years earlier, but also because of the quick actions of policymakers, who determined at all levels of government — municipal, provincial, and federal — to take the threat pretty seriously.
As March progressed, I noticed with each passing daily walk just how serious the city was: they were closing everything. It wasn’t just restaurants and malls; even Ruff’s favorite dog park was shut! While some of the decisions were ham-handed and seemingly arbitrary, one thing was clear: the experts who were advising our government did not think it wise to leave adherence up to the voluntary good graces of our better selves alone. So rather than relying on voluntary compliance to flatten the COVID-19 curve, our government actively ensured that lockdown measures were mandatory through forced closures and penalties. Those who didn’t adhere to the rules endangered us all, so we were generally fine with stiff penalties that applied to anyone caught flouting the guidelines.
The alternative to mandatory lockdowns was relying on individuals to be responsible. I recall receiving a Whatsapp forward of an image created by the Texas Medical Association that showed the relative danger of infection at different venues. Bars, which had just reopened in Texas, were the most dangerous on the list. I wondered how many people in Texas had seen this critical public information. Maybe 5%? 10%? And even if they did, many would still go and then take less precautions as the night wore on; bars are hardly known for bringing out the most responsible behavior in their patrons. Fortunately, in places like Toronto and New York we didn’t have to think about that: someone in the government clearly had that graphic, probably received directly from the healthcare experts whose salaries our tax dollars fund. So rather than relying on others to circulate Whatsapp forwards, our policymakers decided for us: if we want to save lives and go back to normal sooner, bars should be closed for a period. The end.
A second major feature of the lockdowns also stood out: there was a clear and pervasive idea that the rules applied to everyone. People were generally quick to realize that health can rapidly switch from an individual pursuit to a public project, meaning we all need to work together on it — no exceptions. And the experts were clear about it: in a place like Toronto, adherence to social distancing needed to be systemic, meaning everyone, not just select groups of people who opted-in. A friend told me that she saw a pregnant woman getting a ticket for sitting on a park bench, which apparently counted as prohibited use of a park amenity. Much as that struck me as excessive, what occurred to me next is probably what also occurred to everyone else in the city of Toronto who heard it and was not pregnant. If the city isn’t making exceptions for pregnant women, then there’s no way in hell I’m getting away with it.
The COVID-19 response in Toronto was far from perfect, but for most of the pandemic it wasn’t bad — and it helped us flatten the curve enough in the first and second waves that we could both save lives and also safely reopen parts of the economy sooner. Little to none of it was political. The elected leader of the Province, Conservative Party leader Doug Ford, who the New York Times called a “Canadian Donald Trump” in a headline in 2018, was quick to accept the need for lockdowns in early 2020. He made social distancing measures systemic and mandatory rather than individual and voluntary, and called anti-lockdown protestors a “bunch of yahoos.” The benefits of a top-down approach led by government are worth it for the saved lives alone. A study on wearing masks concluded that mandatory mask-wearing in the United States could have saved 40,000 lives in just the months of April and May 2020 alone. Another study said masks could save as many as 130,000 American lives in total during the pandemic. That’s over forty times the number of lives lost during the September 11 attacks. The subtext of the Bloomberg article describing the first study says it all: “Statistical analysis shows that personal choices alone don’t defeat Covid-19.”
A tale of two curves: climate change gets the shaft
Our experience over the last 12 months raises important questions on our long-term sustainability goals. We all get lots of advice related to individual action to make our lifestyles more environmentally friendly, mainly by lowering our carbon footprints by buying ‘green’ products, cycling to work, and eating local veggies. But a young person who is concerned about the future and is asked to buy carbon offsets for a student trip might wonder if it matters, especially when wealthy, older people don’t bother with it, and large corporations generally opt out because this kind of good sportsmanship really doesn’t translate into scoring points. (Technically, voluntarily paying money for carbon offsets actually costs them points.) If voluntary and individual measures are clearly not good enough to bend our society’s COVID-19 infections curve downward, then why do the experts think that such measures will bend our society’s greenhouse gas emissions curve downward?
And there’s the rub. On climate change, inequality, and a host of other important issues, the experts are not advising us to leave it to individual, voluntary action. They know that it won’t work. The issue is that we’re not listening to them. Taking climate change as an example, every serious voice in the elite now claims to believe the science; but few are listening to the policy experts on how we must enact the changes the scientists are telling us we need immediately.
Four months before I attended that fancy gala dinner at the Stockholm City Hall, a Yale professor named William Nordhaus did the very same as recipient of the 2018 Nobel Prize for his work on the economics of climate change. While I don’t know what he thought of the mediocre chocolate soufflé that the Peruvians and I panned, I do know what he thinks is the most effective tool for our economic system to reduce emissions. “Economics points to one inconvenient truth about climate change policy. And that is that in order to be effective, the policies have to raise the price of carbon, or CO2, and in doing that correct the externality of the marketplace,” Nordhaus said in a lecture at Stockholm University, two days before the Nobel ceremony. “I think one of the insights of economics…” He pauses before continuing, at pains to emphasize this next point: “…one that I feel very strongly about… is that if you’re going to be effective, you have to raise the price. Because putting a price on our activities is the only way…” He then cuts himself off to start all over again, almost realizing in real time how important it is that the audience comprehend the scale of what he’s about to say.
“We have to get billions of people, now and in the future. Millions of firms. Thousands of governments… to take steps to move in the direction we want. And the only way you’re going to do that effectively is to increase the price of carbon.” The idea behind a carbon tax is simple: if you make the entity creating the negative externality pay the costs of it (say, through a pollution tax), their incentives change and thus their behavior changes — and our existing system of business, markets, and competition starts to innovate toward greener alternatives. It’s kind of like making a basketball player pay fines whenever they cause harm to fans; if those costs are high enough, players will think twice before playing recklessly and instead find new ways to win cleanly.
While a carbon tax is not perfect, and must come accompanied by a broader set of sweeping policy measures, Nordhaus’ central point is worth noting: if you want to change the behavior of all of the players in the game, you have to change the rules of the game for everyone. Fixing outdated rules seems like an effective way to keep a competitive and productive game going while also minimizing dangerous side effects on the crowd. Instead, on sustainability issues we’re currently being told that our hope lies in standing back and relying on some players sometimes deciding to pursue good sportsmanship, purely voluntarily, even if playing dirty helps them fulfill their legal duty to score maximum points.
For what it’s worth, I tried to find examples where Nordhaus talks about low-carbon ETFs. I found none. Likewise, Thomas Piketty, whose groundbreaking 2013 tome Capital in the 21st Century highlighted the extent to which wealth inequality has risen and is continuing to grow unchecked, talks a lot about raising historically-low marginal tax rates on the highest earners. He does not talk about private equity funds that claim to fight inequality.
Think of it this way: imagine you were tasked with trying to reduce the number of three pointers in an NBA game. Would you ask players to do you a favor and try shooting from a few inches behind the line because you don’t want to bother repainting it? Or just move the three-point line back by a few inches? It’s safe to say that only one of those will work in the fourth quarter of a competitive sports game, since in that situation only points win games, and players are legally obligated and financially incentivized to score points. And no additional points are awarded for playing nice. I suspect that this is what it’s often like for a CEO trying to hit quarterly earnings targets: in a capitalist system that has become excessively focused on short-term quarterly profit performance at all costs, they feel pressure to score a certain number of points in order to ‘win’ against expectations for the quarter, a pressure that is then pushed down through the systems they manage.
That’s why experts like Nordhaus are telling us that the league needs to change the rules in order to change the behavior of the participants in the system. And those rules can’t be voluntary (hey everyone, look at this nice green thing we decided to do for Earth Day!), they need to be mandatory (think fuel efficiency standards for vehicles). Nor can they be individual (let us good and responsible folk do our part and see if that works!), they need to be systemic (everyone must share the burden in order for it to work).
Why do people talk about a ‘free market’ as if one actually exists?
At this point in the discussion, we’re all brainwashed to say the same thing: Gasp, but wouldn’t that mean that the government is intervening in the free market? Fixing the rules of this system so that it produces better societal outcomes is not “intervening in the free market” — especially as there is no such thing as a ‘free market’ in the first place. A market economy is at its core a collection of rules. No rules, no market. Just as every competitive sport has clear rules, competitive markets need rules: no rules, no game. Nor is there one set of preordained rules: every rule, ranging from the number of years a new idea gets patent protection to the corporate tax rate, is a deliberate decision that has implications for the outcomes of the system. If we change the rules of the game, we’ll get different outcomes, all of which can be described as market outcomes. Changing those rules is no more an “intervention in the free market” than it was for the government to create that rule in the first place, or for the NBA to decide to draw a line on the court behind which successful shots are worth three points.
The capital allocation processes that Wall Street manages connect our savings with the most productive uses of that capital in our economy. The people who make those capital allocation decisions are trained to react quickly to changes in expected yields and profitability of investment opportunities. If you were to tell a portfolio manager to lower the carbon footprint of their portfolio, most will nod their heads and agree it’s important, but then return to allocating capital to the most profitable endeavors — exactly as they’re legally obligated and financially incentivized to do. If, on the other hand, a negative externality is “internalized” by the government through, say, a pollution tax, thus lowering the profitability of heavy greenhouse gas emitters, capital allocators will automatically react as fast as they can, allocating less capital to these now less profitable opportunities.
Most portfolio managers intuitively know all of this to be the case. One PM at BlackRock was explicit with me: “I believe in climate change. If we had a price on carbon, I’d lower my carbon footprint overnight — and so would everyone else. But it makes no sense to do it alone and put myself at a disadvantage, and it’s not what I’m legally supposed to do or paid to do.” It was like a basketball player saying “I will happily play safer… if you change the rules for everyone. But as long as you leave the rules the way they are, what you’re asking me to do is to forego points in the name of good sportsmanship. I’m both paid to and legally obligated to score points, and it’s a competitive game, so I’ll pass.”
Updating the rules would make it easier for the players in the game to refocus on what they do best: scoring as many points as they can within a certain set of rules and regulations. It also removes business leaders from attempting to play a critical role on pressing social issues for which they have neither the experience, the democratic mandate, nor the financial incentives and legal latitude to carry out effectively. Updating the rules would mean players who already play clean finally get a leg up on their competitors as a reward for doing the right thing early. Much like the COVID-19 threat, the scale of the challenge means we need to define ourselves by the speed of the slowest and worst performers, not only the best. In a pre-vaccine world, so long as the bar down the street is packed with a raucous crowd that is ignoring all the guidelines, your efforts to wear a mask and social distance are partly wasted.
But there’s an important difference between COVID-19 and climate change. You find out that you’re infected by COVID-19 within a week or two of exposure; by contrast the worst consequences of the slow-moving accumulation of greenhouse gases in the atmosphere will arrive decades after we belch it out. The slower incubation period allows us to indulge in the fantasy that voluntary and individual action alone will somehow aggregate into the systemic change we desperately need right now. But if we can listen to science and change our behavior in order to flatten the curve of something that is killing us quickly, why can’t we listen to science when it tells us to change our behavior to flatten the curve of something that is killing us slowly? In both cases, the experts are telling us that an ounce of prevention is worth a pound of cure.
But somehow the speed of implementing the systemic and mandatory changes we need to lower the COVID-19 infections curve has been both mediocre and yet somehow still far more impressive than the speed and political will we’ve shown to implement any such changes to lower the greenhouse gas emissions curve. We’re ignoring the slower threat because we’re still a while away from the severest consequences of answering inconvenient truths with convenient fantasies. So we’re told that we should leave the rules the way they are, buy an ESG fund to make the world a better place and make money — all at the same time! Sounds familiar. We can flatten the curve and keep all the sports bars open for the big game! Just imagine how much more often that would happen if people only found out that they got COVID-19 a few decades later?
After the global pandemic began and its raw speed and destruction forced us to react, I realized that we were seeing a much slower-moving version of the same story with respect to climate change. We still had the metaphorical bars open. We’d eventually start closing them, reluctantly, in a completely ill-prepared response only fumbled together once the storm was already upon us. My work in sustainable investing was not really doing much to change that, beyond leveraging a short-term gold rush to market new ‘green’ products in every financial asset class from private equity to money market funds. If we want to see the kind of systemic change we need, we must remember the simple and obvious answer that appears curiously underemphasized at Davos and other meetings of the world’s elite: to fix the system, we need governments to fix the rules.
Does this mean that sustainable investing is a problem? A low-carbon ETF can exist alongside a price on carbon — they’re not mutually exclusive. Even if sustainable investing is not a substitute for the rule changes we really need, if it’s doing a little bit of good, what’s the problem — can’t we have both?
This is the second in a three-part essay, click here for the final third.
(NOTE: The original three-part essay was published August 2021; a fourth and final ‘epilogue’ chapter was published here in August 2022.)
It was made freely available to the public in order to spark an important and overdue public debate — so if you find it interesting, please share it with others.
(And if you somehow thought it was awesome enough to pay something for, please direct charitable donations to Rumie, a US 501(c)(3) non-profit and Canadian registered charity, which pioneered mobile-first microlearning for youth around the world. This includes programs that just launched and allow girls and women in Afghanistan to safely continue learning from anywhere on a mobile phone in the local languages Dari and Pashto — see darsx.org.)
