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ESG That Is Dangerous In Theory, Will Prove Meek In Reality

March 02, 2023

It was reported in the New York Times the week before last that the U.S. hedge funds at the top of the proverbial heap had reaped gains for their owners of over $22 billion in 2022. Contrast the previous number with losses in the total hedge fund space that exceeded $200 billion.

That “billionaire” is so often associated with hedge funds in the popular imagination speaks to how few there are relative to the total amount of hedge fund managers. That billions can be made is a reminder that many billions more can be lost. We hear a lot about the vital few in the hedge fund space, but comparatively very little about the silent, 99%+ majority who fail in their pursuit of billions. There’s cause for optimism in this truth.  

The actual, empirical reality about how incredibly difficult it is to succeed in hedge funds is what should have us seeing the future of finance in a positive light, and also the economy in general. While the pundit class would have us believe that the future is bleak thanks to so many money managers allegedly embracing ESG over returns, it’s the desire among all money managers to be elite that reminds us we perhaps don’t have much to worry about.

So what is ESG? In short, it’s a desire within companies to expand the definition of success beyond simple profits. ESG-driven companies are said to factor environmental and societal aims beyond mere profits. Notable here is that some of the largest money managers in the world, including BlackRock, are making ESG a key consideration in how they allocate capital across companies.

These developments understandably have some in our midst worried. What does it mean for the U.S. economy and future prosperity if profits take a backseat to theories about “global warming,” along with gauzy notions of “woke,” “social justice,” and other ideas that have nothing to do with profits?  Worse, what will businesses and investors distracted by feel-good notions of governance mean for a nation populated by 401(k) owners? If profits take a backseat to “woke capitalism,” we’ll all lose. True enough.

To be clear, ESG is on its face rather nonsensical. Businesses are owned by shareholders, and there won’t be shareholders if businesses and investors place their political views above those of investors in pursuit of returns.

At the same time the acquisition of talented employees has everything to do with making money for shareholders. Since people power progress and prosperity, it’s perhaps understandable that corporations in a constant war for talent might embrace what, at least on its face, doesn’t naturally correlate with creating wealth for shareholders.

Which hopefully helps explain the increasingly sanctimonious pose among gargantuan money managers like BlackRock. They can embrace ESG as a way of luring talent inside BlackRock’s headquarters, but they can also embrace it simply because companies focused on ESG are attractive to talented individuals. Think about it.

Once again, the first glance notion of ESG is properly negative precisely because it has everything to do with feel-good notions, and little to do with success. Except that company CEOs are in that position because they're expected to oversee rising share prices. A failure to do so will speed up their exit.  Which seems to suggest that they embrace what’s inimical to profits on the surface in order to attract the talent that once again makes profits possible.

What’s true for corporations is similarly true for money managers. Anyone who has spent any time on Wall Street understands this truth well. Hedge fund managers and portfolio managers are among the most competitive people on this earth. The very notion that they would sacrifice returns in pursuit of feel-good truly beggars belief. That is so because managers who oversee subpar returns are soon enough not managers, and they’re surely not on the path to billionaire status.

So while ESG is yet again on its face an assault of common sense, common sense similarly requires us to think deeply about the incentives that drive company CEOs and the investors who back them with capital. We’re talking about incredibly competitive people, which is a reminder that the ESG we fear in theory will prove rather meek in reality.

This article was originally published by RealClearMarkets and made available via RealClearWire.
John Tamny is editor of RealClearMarkets, Vice President at FreedomWorks, a senior fellow at the Market Institute, and a senior economic adviser to Applied Finance Advisors (www.appliedfinance.com). His latest book is The Money Confusion: How Illiteracy About Currencies and Inflation Sets the Stage For the Crypto Revolution.
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