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🔑 Key Takeaways

  1. When investing, don't rely solely on E.S.G. ratings. Consider factors such as regulation and innovation to truly improve society's environmental, social, and governance outcomes.
  2. Norway's sovereign-wealth fund has adopted a conservative investment approach with a focus on diversification. The fund has decided to sell off oil and gas stocks and has divested from companies involved in coal, tobacco, cannabis for recreational use, weapons, deforestation, and child labor, while frequently monitoring its portfolio.
  3. Put your money into companies with high E.S.G rating as they are more likely to be environmentally responsible, and brown companies should be charged more to encourage them to become greener. The 'E' in E.S.G is more important to investors than the 'S' and the 'G'.
  4. Investing in green technology startups and impact investment funds instead of brown firms can have a significant positive impact on long-term environmental sustainability. Allocating E.S.G. funds requires caution and consideration of its impact on the environment.
  5. Instead of divesting, encourage brown firms to transition towards green technology. Pushing them towards financial distress or raising their cost of capital can lead to short-sighted decisions. Brown firms have potential for huge impact on the environment if they can reduce their emissions. E.S.G. investing can also increase the cost of capital for brown firms.
  6. Instead of divesting or punishing, investors should engage with brown firms to improve their environmental impact and aim for greener output. Being proactive is key to making a positive impact on the movement.
  7. Instead of simply selling off shares, investors can make a real impact by engaging with brown firms to create a more predictable and robust E.S.G. rating system that brings about sustainable change. The digital age has enabled investors to consider a company's externalities and impact on the long-term business model, making it vital to create a rating system that reflects this.
  8. It's not enough to invest in green firms; sustainable investors need to engage with brown firms to make a real impact. Improving board expertise and targeting incentives are crucial for positive results.
  9. Board transformation is crucial for effective management and execution of long-term strategies, with specific focus on energy transition, disciplined capital spending and value creation, and aligning incentives with success.
  10. Companies can open up to new opportunities by listening to shareholders and aligning environmental concerns with profitability. The energy transition is an opportunity, not a risk.
  11. Disinvesting from brown firms may not be the best way to address pollution and climate change. Engaging with them and incentivizing greener practices through government funding can be more effective. CF Industries, for example, plays a critical role in food production and simply shutting them down may result in unintended consequences.
  12. CF Industries plans to reduce their carbon footprint by sequestering their CO2 emissions, equal to taking 400,000 cars off the road annually. Their commitment and profitability prove environmental sustainability and economic necessity can coexist.
  13. Investing in brown firms that are actively pursuing decarbonization initiatives can help accelerate environmental progress, while divesting may simply result in carbon leakage. The financial solutions are needed for decarbonization initiatives, which can make the difference between progress and stagnation.
  14. ESG investing can have unintended consequences if not approached thoughtfully. Investors should understand the purpose and implications of using ESG strategies while considering the potential risks and rewards. ESG investing should promote positive change rather than just meeting investors' demands.
  15. It is crucial to be data-driven and realistic when evaluating the impact of our actions and making decisions. Understanding seemingly insignificant factors can help investors make informed decisions and accurately assess their impact on the market.
  16. Taking risks and saying yes to new opportunities can lead to success, even in the world of sports. The Phillie Phanatic, designed to entertain the crowd, boosted attendance for the Philadelphia Phillies.

📝 Podcast Summary

Why Focusing Solely on E.S.G. Ratings is a Mistake

Focusing on E.S.G. ratings of companies or investment funds alone is a fundamental mistake according to Kelly Shue, a finance professor at Yale School of Management. While investors believe that E.S.G. investing can improve the world and make money, Republican lawmakers criticize it as "woke investing," but they are both missing the point. Norges Bank Investment Management, one of the largest sovereign-wealth funds in the world, is owned by the government of Norway and invested in oil and gas resources. Shue's research shows that rather than relying solely on E.S.G. ratings, investors should consider factors such as regulation and innovation to make a real difference in improving society's environmental, social, and governance outcomes.

The Conservative Investment Approach of Norway's Sovereign-Wealth Fund and Its Portfolio Diversification

Norway's sovereign-wealth fund invests in nearly 9,000 companies, covering 1.4% of every listed company in the world and provides 20-25% of Norway's annual budget. The fund's investment approach is fairly conservative with a strategy of diversification and owning stock in almost every major public company. Norway has decided to sell off the oil and gas stocks in their portfolio, particularly focusing on pure upstream oil and gas producers, but kept investments in larger, more integrated energy firms. The fund has also divested from coal, tobacco, cannabis for recreational use, weapons, deforestation, and child labor reliant companies. Every quarter, the fund combs through its portfolio to see if there are other companies they want to sell off.

Why Investing in High E.S.G Rated Companies Matters

Investors should put their money into companies with high E.S.G rating rather than those with low rating on environmental, social, or governance dimensions. 20% of firms are responsible for almost all of the environmental impact that firms have on the world, and brown firms should be charged more to raise their cost of capital which will encourage them to become greener. Services firms tend to be greener while firms in energy, agriculture, and transportation tend to be browner. Brown firms have little incentive to become green based on E.S.G investing so far. Focusing on the 'E', environmental impact, is important, and investors care more about the 'E' than the 'S' and the 'G'.

Targeting Green Energy Startups for Better Impact Investments

Investing in brown firms with the hope of motivating them to become green is counterproductive, as brown firms are more likely to continue their current operations or cut corners instead of investing in green technology. Instead, targeting green energy startups and impact investment funds that promote new green technologies is a promising strategy. Most E.S.G. money is currently going towards firms that already don't pollute much, like banks and software firms. Additionally, increasing the cost of capital for brown firms can lead them to become even more brown, rather than motivating them to go green. Therefore, investors should be cautious about where they allocate their E.S.G. funds and consider the long-term impact of their investments on environmental sustainability.

Why Divesting from Brown Firms in the Energy Sector Might Be a Mistake

Divesting away from brown firms in the energy sector could be a mistake. Such firms are most likely to develop new green technology that could benefit other firms and the world. Pushing a brown firm towards financial distress or raising its cost of capital can make it more short-term oriented and less future-oriented, leading to short-sighted decisions. Brown and green firms have a huge scale difference in their pollution levels, with brown firms polluting 260 times as much as similarly sized green firms. If brown firms can cut their emissions by just 1%, it can be better for the environment than green firms achieving 100%. E.S.G. investing is more mood-affiliation than an investment strategy and can increase the cost of capital for brown firms.

The importance of engagement with brown firms in the E.S.G. movement

The E.S.G. movement has about $35 trillion globally invested in it, and it's expected to grow to about one-third of all assets under management by 2025. Brown firms exist in sectors that are crucial to a well-functioning society. It's better to make these sectors more green per unit of output than eliminate them entirely. Investors should engage with brown firms' management to change their environmental impact instead of divesting or punishing them. Kelly Shue, a Yale finance professor, believes E.S.G. investors have their heart in the right place but often fail the logic test.

Engage with Brown Firms to Create Sustainable Change

Investors should engage with brown firms to help make them greener instead of simply selling off their shares. The E.S.G. movement is driving corporate transparency through its rating systems, but according to Chris James, founder of Engine No. 1, these ratings are not very useful and lack correlation between multiple rating parties. He believes that the transparency brought by the movement is a result of the digital age, allowing investors to consider a company's externalities and their impact on the long-term business model. However, he suggests creating a more predictable and robust rating system that's linked to what 'good' or 'bad' actually means instead of creating one that is similar to the rating system for bonds.

Engaging with Brown Firms for Sustainable Investing

Investment in green firms alone may not bring about the desired sustainable changes. Sustainable investors need to engage with brown firms as well to make a meaningful difference. ExxonMobil was an outlier in performance despite having great assets and engineering talent, which makes it a prime candidate for sustainability-focused engagement. A governance issue arose due to the lack of energy expertise on the board responsible for making decisions that impact the company's activities. Therefore, ensuring adequate expertise and diversity on boards is crucial to achieve positive results. Sustainable investing strategies need to target the incentives of brown firms to make them more sustainable instead of merely directing capital towards green firms, which can have counterproductive effects.

Overcoming Weak Governance in the Energy Industry through Board Transformation

A weak board can result in poor management and lack of execution of a long-term strategy. ExxonMobil faced this challenge due to the C.E.O's poor execution. However, thanks to responsive management and meeting shareholders' demands, ExxonMobil has pivoted its business towards creating value in an energy transition and executing on the core business much better. This was possible because of a well-managed debt load, which enabled them to invest in decarbonizing their operations. The activist campaign against ExxonMobil was driven by the need for better governance to allow for decarbonizing their operations. It calls for a board that has people with successful energy experience, disciplined capital spending, a board committee that looks at energy transition, and aligned incentives of compensation with value creation.

ExxonMobil invests in low-carbon solutions and transforms into sustainable organization.

ExxonMobil's investment in low-carbon solutions business, which was once an existential threat, has now become one of the three pillars of the organization. Shareholders, including those who did not care about environmental impact, were convinced to vote for board members proposing changes that would make the company more profitable and sustainable. The changes ultimately led to the creation of a low-carbon-solutions business and decarbonizing of their own operations. The success story of Chris James shows that large companies could open up to opportunities outside their traditional business if they are more open to new ideas proposed by shareholders, and that environmental concerns can align with profitability. The energy transition should be viewed as a humongous opportunity rather than an existential risk to businesses.

Why E.S.G. Investing Alone Is Not Effective for the Planet

The E.S.G. investing movement is not effective for the planet despite its good intentions because disinvesting from brown firms raises their capital cost and encourages them to make short-term decisions leading to more pollution. E.S.G. investors should interact with brown firms rather than shun them. Government funding like the Inflation Reduction Act can provide massive subsidies and tax credits to address pollution and climate change to incentivize brown firms to get greener. CF Industries is the world’s largest ammonia producer, and their disappearance would lead to an extraordinarily high cost of food globally and higher greenhouse gas emitters. Their main product is created by taking natural gas, methane.

CF Industries to Sequester CO2 Emissions with ExxonMobil Deal

CF Industries, a major ammonia producer, plans to reduce its carbon footprint by sequestering their CO2 emissions instead of venting them into the atmosphere. They have signed a deal with ExxonMobil to sequester 2 million tons a year of CO2, which is equal to taking 400,000 cars off the road annually. The Inflation Reduction Act played a critical role in this process as it provided a potential credit of $85 per metric ton of CO2, making it an economic necessity for CF Industries. However, the company had already committed to decarbonizing their network before the subsidy. This approach is a positive step towards environmental sustainability and a profitable investment for the company.

Investing in Brown Firms: A Key to Decarbonization?

Investing in brown firms that are making an effort to become less brown can help accelerate decarbonization initiatives that are beneficial for the planet. The regulatory environment plays a crucial role, and shutting down production facilities can result in carbon leakage. The paper's definition of green versus brown based on carbon intensity as a function of revenue can encourage hiding away high-emissions businesses. The investment dollars in brown firms should differentiate those who have a real plan of action and are taking tangible steps to decarbonize their network. The financial solutions are needed for decarbonization initiatives, which are currently expensive for firms to afford. Investing in these firms can be more beneficial than punishing them by selling off their shares.

The Misconceptions and Negative Impact of ESG Investing

ESG investing may not always result in better environmental impact as some strategies lack clear descriptions and good consequences, leading to investors losing money in terms of fees and returns. But it's not a scam as providers are delivering exactly what investors claim they want, which is to invest in green firms and avoid brown firms. The negative consequence of the erroneous belief in ESG investing is highlighted in Kelly Shue's research, which suggests that green and brown firms should be equally rewarded for reducing emissions. People need to think more clearly about why they want ESG investing and avoid actively counterproductive measures. A.Q.R. and others are just responding to investor demand by developing long-short funds.

Optimism Bias and the Importance of Realism in Decision Making.

People tend to be overly optimistic about their ability to effect change than in reality. This is a common finding in behavioral economics research. This also applies to researchers like Kelly Shue who admits being too optimistic despite being aware of it. This highlights the importance of being realistic and data-driven when making decisions and evaluating the impact of our actions. The Economics of Everyday Things highlights how sports mascots like Phillie Phanatic can bring more people to baseball games despite being unrelated to the sport itself. This shows how a seemingly insignificant factor can have a significant impact on the overall market. Understanding these nuances can help investors make more informed decisions and accurately assess their impact on the market.

How the Phillie Phanatic Became an Iconic Mascot in Sports History

The Phillie Phanatic, the beloved mascot of the Philadelphia Phillies, was created after the team saw the success of the San Diego Chicken, a man dressed as a chicken who entertained fans during baseball games. The team realized they needed to up their mascot game to boost attendance, so they hired Bonnie Erickson, a top designer, to create a new character. Unlike the previous mascots that were more like logos, the Phillie Phanatic was designed to entertain the crowd. The success of the Phanatic shows that sometimes taking risks and trying something new can pay off, even in the world of sports. Raymond, the creator of the Phanatic, learned early on in his career to say yes to anything and everything, which ultimately led to his involvement in creating one of the most iconic mascots in sports history.