The $200bn "complete fraud".

"And you will know the truth, and the truth will set you free" - John 8:32

In February of last year, the CEO of Social Capital, Chamath Palihapitiya, called ESG investing “great marketing”, “complete fraud”, “joke” and “so ridiculous” - on CNBC of all places.

I share Palihapitiya’s concerns. But many investors do not. As the chart below clearly shows, Environmental, Social and Governance (ESG) investing has become increasingly important in recent years. In 2021, the money managed in ESG funds have reached nearly £200bn.

If Palihapitiya is correct, the “ESG fraud” would be 4x the Ponzi scheme ran by Bernie Madoff for 20 years.

In a previous newsletter, I have covered why ESG investing does not make sense from a valuation perspective, based on analysis done by NYU Professor Aswath Damodaran and ex-CIO for Sustainable Investing at BlackRock, Tariq Fancy.

In this publication, we will explore the origins of ESG, the ethos behind it, how its promises are rooted in a political ideology that is net damaging to society and the economy and how ESG investing may be a huge misallocation of capital.

The origins and ethos of ESG investing

The birth of ESG investing is, to some extent, and just like with any other good non-practical, ideologically-driven concept, shrouded in mystery with the exact origin - time and location - being a legend for boardroom meetings, international conferences and academic panels.

Some argue that ESG was born out of the 2001 launch of the FTSE4Good Index Series, which had “the objective for UK pension funds to take account of social, ethical or environmental (SSE) issues”.

Others suggest that ESG came out of “socially responsible investing”, a notion that grew in popularity during the 1980s and 1990s but with roots that “trace back two millennia”. Such suggests Baline Townsend, Executive Vice President & Director, Sustainable, Responsible and Impact Investing at Bailard in the Fall 2020 issue of the Journal of Impact and ESG Investing.

However, the modern story of ESG began in mid-2000s with two publications: the United Nation’s PRI report called “Freshfield Report” (2005), which was done with the assistance of global law firm Freshfields Bruckhaus Deringer and the “Who Cares Wins” report (2004) , authored by Ivo Knoepfel and produced by an initiative that was supported by the International Finance Corporation (IFC) and the Swiss Government.

The UN PRI is an arm of the United Nations formed between 2005 - 2006.

“In early 2005, the then United Nations Secretary-General Kofi Annan invited a group of the world’s largest institutional investors to join a process to develop the Principles for Responsible Investment.

A 20-person investor group drawn from institutions in 12 countries was supported by a 70-person group of experts from the investment industry, intergovernmental organisations and civil society. […] The Principles were launched in April 2006 at the New York Stock Exchange.”

In other words, about 16 years ago, less than 100 people (20 investors and 70 experts) decided on six Principles for Responsible Investment¹.

“At the time [2006], 63 investment companies composed of asset owners, asset managers and service providers signed with $6.5 trillion in assets under management (AUM) incorporating ESG issues” - Baja Corporation

As we can see from the chart below, the number of both signatories (investment companies that pledged allegiance to the six principles) and the AUM they manage (i.e. the financial firepower backing them) has grown substantially: today, over 4,000 asset managers (with over $100 trillion in aggregate AUM) have backed the idea of ESG investing.

Source: www.unpri.org

But what exactly is ESG? How is it defined? Well, the answer depends on who you ask:

The Financial Times defines it in a recent article as “doing well by doing good”. Blaine Townsend implied that ESG can be defined as “do no harm. That is the central concept of traditional faith-based investing and, to some degree, the central concept of traditional socially responsible investing.”

Meanwhile, Harvard Law School views ESG as “[…] a set of factors used to measure the non-financial impacts of particular investments and companies”. Similarly, McKinsey thinks of ESG as a set of concerns that translate into some “criteria”. Forbes stated that ESG is “the new buzz word” and KMPG boldly claimed that this concept “must be embedded in your strategy and form the overall narrative and purpose of your organisation”.

Vague? Unclear? Not very defined for a notion that informs how billions of capital are allocated and which continues to gain importance? That’s because of the philosophical underpinnings of ESG. In fact, we can only make sense of ESG from a philosophical perspective.

“ESG grew out of investment philosophies clustered around sustainability and, thereafter, socially responsible investing” - Harvard

ESG sits within a broader menu of terminology (responsible investing, green finance, ethical investing, corporate social responsibility, etc.) all linked to one key concept: sustainability.

The economic and ideological roots of ESG

Sustainability has become the key word in economics, finance, politics and academia. Everything must be made sustainable - consumption, production, capital allocation, political views, ethical values, everything has to fuel this vision of a world with a sustainable future.

But what does “sustainability” mean, where does it come from and how did it become so ubiquitous?

On the surface, the notion of sustainability appears to be rosy and positive. In 1987, the United Nations Brundtland Commission defined sustainability as “meeting the needs of the present without compromising the ability of future generations to meet their own needs.”

There are several issues with the above definition. For example, there is no guarantee that future generations won’t view our actions and believes as criminal and barbarian or that they would value what we build today and preserver instead of destroy².

However, beneath the apparently benevolent attitude baked into “sustainability”, the concept’s origins are rooted in, let’s say, unfriendly ideas that came to light during the middle of the 20th century.

In economics, one of the key documents from which the idea of sustainability emerged was a 1972 publication by an organisation called the Club of Rome (which was established in 1965 out of “concern for the long-term future of humanity and the planet”).

The publication is a book called “The Limits of Growth”. The analysis’s core premise was that economic growth is limited by finite resources on earth, an issue accelerated by an expanding population.

For a while, the main argument made by the book was true but not due to the reasons stated in it, which relied on extrapolation of past data in order to construct a vision of the future that appeared to be certain.

Rather, the limits to economic growth were (and still are) the technological advancements that enable us to extract and convert raw energy into useful energy. However, these limits are slowly but surely broken, with the prospects of fusion energy becoming more and more realistic.

Since its inception, the Club or Rome has published multiple books and reports, most of them focused on the imminent deterioration of the natural environment. Many of these documents present a pessimistic view of humanity and human actions delivered in an alarmist tone³, predicting the inevitable end of our civilisation if nothing changes: i.e. if we do not focus on sustainability.

Leaving aside the fact that despite multiple doomsday scenarios, the world’s mighty policymakers, scientists and business magnates have done mostly nothing, and that these scenarios have been proven wrong for over 50 years, on the Club of Rome’s website there are a number of publications which reveal the broader ideological ecosystem in which the notion of sustainability resides.

Titles such as “Limits to Privatisation” and “Capitalism, Short-termism, Population and the Destruction of the Planet”, among others, reveal the ideological alliance of the notion of sustainability with anti-capitalist, pro-left-wing thinking. This is no coincidence.

Ideologically, “sustainability” emerges from the works of Herbert Marcuse, one of the key figures behind neo-Marxism (the undead version of Marxism that pre-dates the current “woke” identity politics).

As James Lindsay explains in a lot of detail, the notion is derived from Marcuse’s writings throughout the 1960s and 1970s, in particular from the “One-Dimensional Man”, “An Essay on Liberation” and “Counterrevolution and Revolt”.

The idea of “sustainability” is in fact Marcuse’s “new sensibility” (cause for pushing left-wing political agendas, even communism), born out of a profound distain for the prosperity of blue collar workers under capitalism.

Given the (radical) left-wing ideological source from which sustainability and the whole vocabulary associated with it (ESG, responsible investing, green finance, socially responsible finance, climate change, diversity, inclusivity, equity, etc.) derives, it is no surprise that many of the initial supporters of early ESG-like investments were also left-wing thinkers and activists in the USA during the 1960s - 1970s.

Knowing the background of sustainability, the parent concept of ESG, you may be wondering what is driving the rise of ESG?

Many things which are not related to efficient capital allocation, but mainly politics and propaganda.

The true ESG ethos: propaganda and politics, not asset allocation

ESG is a code word for a type of (political) activism that manifests through a) relentless PR campaigns, b) narrative construction by elite intellectuals in academia, c) capital allocation decisions based on “virtue signalling” and d) ruthless politics.

As early as 1970, Milton Friedman drew attention to dangers of underlying narrative of “social responsibilities of business in a free-enterprise system”, arguing that business people “who talk this way are unwitting puppets of the intellectual force that have been undermining the basis of a free society these past decades”.

Nowadays however, the PR campaigns of ESG investing are everywhere, from newspapers talking about it all the time and companies reporting on ESG-related matters, to big international institutions like the IMF saying that “humanity cannot pass up the golden opportunity of a green, inclusive, and resilient recovery”, the CEO of BlackRock warning about the urgency of moving towards sustainability (with more funds) and so on⁴.

“There are many organizations that contribute to stakeholder capitalism and ESG, but the key pioneers have been the World Economic Forum created and led by Professor Klaus Schwab. A subgroup of the World Economic Forum is the International Business Council which comprises the top 120 largest global companies. They are leading the way to create a consensus market led view of how to implement ESG” - - Baja Corporation

However, you must be careful how you disagree with this consensus and the “golden opportunity” that it provides, unless you want to be eradicated from public discourse (which is now a realm built on private-public partnerships) or worse (e.g. career loss). For example, Google recently announced that “climate denial” (i.e. any form of disagreement with the mainstream narrative on climate change) is banned from its platforms.

This relentless PR activity is coupled with censorship politics and with what can only be called cult-like views (a strong sign of propaganda) - “more virtue equals more money”, “doing well by doing good”, “ESG isn’t something you do. It’s everything you do and how you do it” and “bringing together money and meaning” - should make one thing more critically about ESG.

Indeed, behind the positive slogans, there is a thick layer of hypocrisy that persists throughout the movement towards sustainability.

As John Stossel points out in a video called “The ‘Socially Responsible’ Investment Scam” many of these funds (and companies) have been suspected of what is known as “greenwashing”.

For example, asset managers put the ESG label on the funds to attract capital (mostly from millennials apparently) and then they invest in most profitable companies, regardless of their supposed “ESG ethos”. The fact that millennials are the primary market for these funds is no coincidence: a $30trn wealth transfer is underway and is important for that wealth to be put in the “ethically correct” places.

Also, too many of the advocates for ESG-related issues (especially climate change and human rights) travel by private jets and are silent on China’s treatment of Uyghurs.

Geopolitically, some of the ESG rhetoric makes some practical sense. For example, Europe may want to get rid of Russian gas and build its own energy infrastructure which, due to its geography, must be mostly green energy. Nevertheless, this still underlines the political character of this notion more than its closeness to fiduciary duty of doing what’s best for investors (not stakeholders).

Given the above analysis, we should ask ourselves if ESG investing is really about efficient capital allocation or political activism. If the latter is the reality, then the world is putting an increasingly large sum of money in unproductive ventures.

We didn’t even talk about the ESG scores - which try to form a quantitative method of thinking about “faith-based investing” or other qualitative aspects of investing, but I hope that I raised sufficient questions for more people to look at ESG and its parent concept - sustainability - more critically.

Thank you for reading.

1. Note the words “civil society” - what does this mean exactly? Rich people? Elite intellectuals? Sophisticated people, as CNN and the NYT would call them? We will never know.

2. Looking at the vandalization of American and British heritage during the BLM riots of 2020, I would say that future generations are by no means inclined towards preservation and understanding of what happened in the past simply by default. Same things I could say about Romania, my home country, where current generations make little effort to know their own history and treat the sacrifice of those who died during the 1989 revolution with indifference.

3. If you question the extent to which these alarming claims are true, you are labelled a conspiracy theorist and judged as mad or stupid.

4. Note that the imminent, upcoming tragedy of not achieving sustainability - a process that would cost many lives and livelihoods - is a “golden opportunity”: of course, the solution to deforestation, air pollution, racism and other ESG-related issues is indeed another mutual fund.