ESG is a short

The FT mentions that hedge funds have seen an opportunity in the crowed trades that ESG investment represents. Go short such inflated trades. About time, we would add.

AlphaValue has repeatedly been upset by the fact that ESG mandates are filled up by buying the same cold databases leading to the same simplistic moves: say, go utilities because they green up, dump steel because it is long carbon. The proper trade as we mentioned two years ago is exactly the reverse: choose stocks for which the marginal Euro invested in emission cuts is most effective. Adding oxygen or a scrubber to a steel mill is more effective in tons of avoided carbon than burning cash on another set of windmills. 

It is also very efficient from the point of view of the corporate as its emission figures when set against capital employed (the only consistent metric that we deploy to assess cross-sector greening-up efficiency). The emission pay-back is much higher than on new projects. Which is really the point of ESG regulation imposed at great cost to corporates.

End of easy money adds to the pain

In parallel, the crowded greening-up trades have been shaken up by the end of easy money. This compounded their demise. Looking at cash generation now rather than in a distant future is a sobering filter to investment decisions. Every market commentator made that point by early 2021 but ESG funds have been tripped badly nevertheless. Pain added to injury when Oil stocks had their Q4 epiphany. 

Taking a more holistic view that AlphaValue developed in a September 2021 review ("The Green Deflagration"), greening-up goes against shareholders’ best interests whichever way one looks at. The idea that greening up is a growth mechanism is an oxymoron as green is better summed up as rising uncertainty and rising cost of capital with no better expected returns as it replaces a process by another greener one, not a more profitable one. 

Risky and riskier

There is worse to come from ESG straitjacketing of investment decisions as illustrated by the blows suffered by DWS  (fund management) and Orpea (senior care). It takes a whistle blower or a book to crash a business. While courts will take ages to sort out whether there was a case in the first place, ESG funds will dump the assets right away just like a money manager with an investment grade mandate will dump debt that goes non-investment grade. In essence, ESG mandates create a market mechanism where a tweet prevails on FCF development. Admittedly there are instances when a well-aimed tweeted blow crashes the FCF outlook in a self-fulfilling destructive loop. 

The point here is that ESG adds to risk from an unexpected corner, that of various stakeholders with all sorts of constructive or destructive missions. Shareholders just do not have the time and resources to go through qualitative arguments inflamed by stakeholders. 

Corporates have been rightly lamenting about the considerable efforts imposed on them to track the untrackable. It may well be that this opens all sort of fresh avenues for pressuring corporates into constituency corners that will be at a systematic cost to shareholders. 

In short, ESG is a good idea, the cost of which is likely to be way above what well-intended ESG fund managers thought. The pressure of hedge funds is a salutary one to sink in the message that there is a complex world out there that cannot be summed up through backward-looking data sets collected by robots. ESG investing is very hard, very expensive, work.

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