THE concept of environmental, social and governance (ESG) has become very big especially in the financial markets in recent years. Before ESG became the hype, the key word used was sustainability. It was all encompassing and far reaching, suited for developmental strategies of companies and organisation alike. Of course, by 2016, the United Nations Sustainability Development Goals 17 became the globally recognised agenda. If I were to sum it all up, the idea behind these well thought out concept is about social good.
The Employees Provident Fund (EPF), as the largest fund in our country with close to RM1 trillion in investment assets, have led the way in this space. In walking the talk, EPF being the buy side major client, encouraged the sell side research fraternity to include ESG metrics in their reports as part of the future industry standard. The adoption, while recent in Malaysia, is not new overseas. Various indexes like the FTSE4Good Index series (a series of benchmark and tradable indexes for ESG investors) has existed since 2001.
In short, the ESG concept, while it is all the hype today, is not a novel idea. It has been around for longer than most investors would care to notice.
Paul Tudor Jones II, is the founder of Tudor Investment Corporation and billionaire hedge fund manager whose early success came when he correctly predicted the 1987 Black Monday crash. During the time, he tripled his money with large short positions in place. His bet on the collapse of the United States stock market then returned 126% net of fees, earning an estimated profit of US$100mil (RM418mil). After making his money, he co-founded the Robin Hood Foundation (not to be confused with the Robinhood Markets Inc, the popular commission free trading app), which was one of Forbes 100 largest charity foundation in 2016 with net assets of US$391mil (RM1.6bil). What is more interesting was when Jones founded a non-profit Just Capital to help investors learn about companies which are considered “just”. This led to Goldman Sachs creating an ETF known as JUST US Large Cap Equity ETF (Ticker: JUST) in 2018 which comprised of companies believed to be “just” based on the research of Just Capital. Chart 1 shows the performance of JUST ETF since its inception to date on June 7 2018, with a return of almost 57% as at 29 Sept 2021, equivalent to an annualised return of 17.5% per annum.
The big question is how to balance the focus on ESG versus social cost, companies’ balance sheet or profitability, without going overboard. China’s recent power outage impacting 16 provinces and 31 cities is a clear example. Coal being the main power generation source for the nation has been criticised both within China and by other countries as a major cause of pollution, resulting in climate change. Yet with an essential daily need for common people disrupted, is this the price to pay for aggressive carbon neutrality policy by China’s government in their pursuit of lower carbon emission goals or just another instance of the global supply chain disruption?
Due to the paradigm shift in mindset and approach, our country’s economy, which is heavily reliant on the oil and gas and palm oil sector, would appear to be on the short end of the stick. Commodities of such which were deemed finite and precious to the world are now being discounted in valuation premium due to ESG concerns and the impact to the world. Take the example of the palm oil sector, although crude palm oil (CPO) price has been on a tear in the past one year, reaching record highs of RM4,500 per tonne, this has not translated well to the share price performance of the companies. At least, the share price has not moved in tandem with their earnings and dividend growth as shown in Table 2.
This stark contrast to the tech sector performance illustrates how the funds and investors value different sector. Rightly or wrongly is subjective. Personally, I do like palm oil as a crop for edible oil as its benefits far outweighs the negatives. It is also a highly efficient crop as oil palm produces nearly four tonnes of oil per hectare, which is roughly five times, eight times, and ten times higher than rapeseed, sunflower, and soybean yields, respectively.
For movie purveyors, the film “Ms Sloane” starring Jessica Chastain depicts how lobbyist work behind the scenes along political corridors to influence economic policies. They are usually funded by interests groups or wealthy individuals who may be affected by policies of the day. In order to sway politicians and lawmakers to pass legislation or policies which benefit them, lobbyist are engaged to do the necessary evil. In the film, “Nutella Tax” was about to be introduced which would impact the palm oil exports to European countries. Hence, interests groups from Indonesia engaged Ms Sloane’s services to influence lawmakers to prevent the “Nutella Tax” from coming to fruition.
To put it in context, “Nutella Tax” was an actual policy which supposedly imposed 400% tax hike on palm oil shipped to France. It was given this nickname because palm oil is a popular ingredient in Europe’s favourite chocolate hazelnut spread, Nutella. This was introduced by French senator Yves Daudigny alleging that oil palm is bad for health because it contains high levels of saturated fats and wanton deforestation. These allegations are mostly untrue and part of a smear campaign towards palm oil due to its efficiency. If anything, oil palm trees are actually environmentally- friendly among all oil crops because palm oil production requires less energy, land and fertilisers, compared to other vegetable oils on a per-litre basis. It has a productive lifespan of 20 to 30 years, unlike rapeseed, soya and sunflower which has to be uprooted every four months during harvest. Oil palms also occupy less than 5% of the world’s land under oil crop cultivation.
In order to meet this growing concerns and pressure by interest groups, the Roundtable on Sustainable Palm Oil (RSPO) was established in 2004 to promote the growth and use of sustainable palm oil products through global standards. This is how a traditional industry is required to up their game at a global stage to meet the demands of various stakeholders. That being the case, concepts of ESG and its likes are here to stay whether we like it or not. For the investment community, embracing the change may be uneasy but it is the way forward.
With each new generations that comes along, priorities shift. In the olden days, the focus is just to survive whether the plague, wars or famine. It then move on to making ends meet and breaking out of the poverty cycle. Later on, it became about getting out of the rat race and enjoying retirement. With the millennial today, everything is about the purpose and passion of life. This symbolise progress in civilisation and progress is always good. At the end of the day, the stock market is no different from the real world out there. It is a collection of diverse ideas, personalities and wisdom all in an interconnected realm of investing. To do well, investors will need to be adaptable and importantly, to take into consideration of social good when investing.
Ng Zhu Hann, is the author of Once Upon A Time In Bursa. He is a lawyer and former chief strategist of a Fortune 500 corp.