The ESG Mirage

Chris Gates:
All right. So I think the best way to start is to just jump in. So let's start with what is ESG? Okay, ready? 3, 2, 1.

Danny Crichton:
So if you think of an acronym, climate change is really pleasant. And I don't know, social welfare. There are terms that are very clear. And then there's this ESG, which has to be the most technocratic, dumb term, environmental, social, and governance. I can never even remember what it means. I don't think anyone knows what it means.

Chris Gates:
I mean, when I hear it, all I can think about is spice. That's the only image that comes to my mind.

Danny Crichton:
Well, it sounds like MSG, which I can assure you MSG is about 20 times better than ESG, but it's one of these completely fake concepts, which has just spiraled in popularity. According to Bloomberg Intelligence, $41 trillion in assets under management 2022, $50 trillion by 2025 will be managed under the rubric of ESG.

Chris Gates:
Why? Why the rise?

Danny Crichton:
Well, I mean, a lot of the asset managers, pension funds in particular, are super sensitive about investing in "good things." So if you are the Norwegian State Sovereign Wealth Fund, and you have trillions of dollars of oil wealth, which the Norwegians like to not remember too well, they want to make sure that that money goes into high quality, climate neutral, climate positive projects. CalPERS, one of the largest pensions in America for the state of California's teacher union, similarly a trillion plus dollars in AUM. They want to make sure it goes to positive, societally beneficial companies and investment assets.

And so what I think you had over the last decade is a lot of these massive asset managers came together. Were sort of like, how do we figure out what to invest in? We want to invest in socially positive things. We don't want to invest in corrupt countries. That's where that governance, that's the G. We don't want to go into a variety of emerging markets where there's a ton of corruption that's being stolen, even if we can make money. It's not a saying that you can't make money, but we don't want to go to a corrupt place. And then on the environmental side, obviously there's been a huge awareness, consciousness of climate change going on around the world.

Chris Gates:
I mean, all those things sound amazing. We should be putting money behind that. So I don't really understand what the problem is.

Danny Crichton:
It's one of these things that if you were to just do it at a very high level, there's no problem. It's a very positive, it's values driven. It's saying, "Hey, we want to do X, not Y." And that's fine. I mean, you should be able to do that in a qualitative sense. You can get a feel of projects. And you can do that on a qualitative, a couple managers with some cash trying to invest in that. What I think gone wrong in the ESG market is the scale up, which is when you went from tens of billions to literally tens of trillions of dollars of assets. Suddenly you went from a model of, "Hey, I can meet the founder, I can meet the company." Think a chef at a farm to table restaurant. I can go visit Napa, see my grapes being grown, and I know it's a safe, high quality project.

Whereas when you get to huge scale at $50 trillion by 2025, based on the estimates, you don't have the ability to do that. You have to quantify it. You have to be able to evaluate thousands of things simultaneously in an Excel spreadsheet. And unfortunately, concepts like environmental and social and governance just can't be reduced to a spreadsheet.

Chris Gates:
So is it a definition problem? What if we improved or narrowed the scope of ESG?

Danny Crichton:
If we had a solid definition of what ESG is and everyone's trying to jam themselves in, that would actually do the function of what people want, which is people would go, well, gee, I want to be less corrupt. I want to make better green technology. I want to be better on climate, therefore I'm going to try to fit the definition and get a higher score, whatever the case may be. We're in a far worse nightmarish scenario, which is there is no definition.

What is a good climate company? One of the examples I wrote in the newsletter was around oil companies. And this is actually a huge debate, which is, if I'm ExxonMobil and I have let's say $100 billion of oil in the ground that I know exists, I own it. It's in drilling sites that I have control over, and I can pull it out of the ground. If I choose not to pull it out of the ground, am I a green company? I still am an oil company. I'm still producing oil, but I'm choosing to forego some level of carbon emission in exchange for being a greener company. Is that green? And so it's fundamentally, one of these things is like you have to have trade-offs. And I think it's one of these classic definitions of no one can ever be happy with any definition.

Chris Gates:
So you're saying we're fucked? Is that what you're saying?

Danny Crichton:
I feel like 90% of all of my articles end up with we're all fucked. Thank God my next article isn't about a book called The Collapse of Complex Societies, but what I would say is twofold. One is there is an immediate problem around ESG labeling, which is many funds have been designated ESG. And what we're finding is in many cases, the asset managers are doing almost no work. And so the Securities and Exchange Commission, BaFin, the financial regulator in Germany, other European regulators are actually cracking down very hard with multiple asset managers and advisors being fined and essentially admitting to what is a form of fraud, which is saying that you have a green fund that is not green, and the SEC is promulgating new rules that are saying, hey, if you're going to call something like the Green Investment Fund, you actually have to have very clear criteria of what makes something green and why it is in it.

Or as I joke, it better be about trees and not like the money form of green. And the second piece, which gets at the larger point, is I just think it's a worthless project.

Chris Gates:
You're saying trying to label ESG is a worthless project, not the effort to put money behind what ESG stands for?

Danny Crichton:
Well, that's the precise nuance, and I think that's what's been so hard. This is why Twitter is a terrible medium to debate this, but there's an incredibly important nuance and distinction between it's good to improve the world and have these companies improve their operations. But the mechanism we're doing, the ESG labeling and indexing and quantification doesn't work. It's not the solution to getting to A.

And so to me, the solution again is to really understand the context of a lot of these companies, to actually do due diligence, to do work. Similar to what's happening in venture capital, in which over the last year we've seen folks who were investing willy-nilly in companies and now they're getting their ass handed to them. I think the same thing is happening in the ESG world. The SEC is cracking down. They're going to be much stricter going forward. And that really brings up a huge question long term of will this industry survive or will they come up with another expression like BRCS? I don't know if you remember BRCS in the emerging market for Brazil, Russia, India, China, and South Africa, I think was the S, but I think it's one of these acronyms that had its moment in the sun, and its definitely, definitely questioned by more and more people.