Opto sits down with former distressed debt investor turned sustainable investing market critic Tariq Fancy to get his take on how to identify impact investments in a time where oil prices and defence stocks are soaring.
A meeting room at a coworking space named after the Financial Times’ editor-at-large Gillian Tett feels like a suitable location for our discussion with environmental, social and governance (ESG) investor Tariq Fancy.
The ex-CIO of sustainability at BlackRock has become such an outspoken voice in this field that he is regularly called upon to debate the intrinsic impact of socially responsible investing. In early May, Tett and Fancy engaged in a Q&A that saw them both agree there is a lack of evidence demonstrating how low-carbon investment assets help to fight climate change, and that ESG reporting needs more consistent, credible and enforceable standards.
It’s this misconception — that ESG investing will save the planet — that he blew the lid off in a confessional essay titled ‘The secret diary of a sustainable investor’, published on Medium in August 2021. Praised for its account of an insider’s struggle to navigate the clear disconnect between sustainable principles and profit, the three-part paper chronicles Fancy’s journey from evangelising the industry to decrying it as a “dangerous placebo”.
Like many ESG advocates, he’d initially been driven by meaningful motivations. Inspired by a former roommate from business school, Fancy set up the Rumie Initiative, a digital non-profit that advances access to education through technology, before becoming an ESG dissident.
Since wrapping up a two-year stint at the world’s largest asset manager and publishing his explosive essay, he has gone back to charity work. Although that’s not stopped the former investment banker from calling out the industry for promoting the fallacy that society can reach net-zero carbon emissions through investing in the markets.
Eco-conscious investors piled $2.7trn into ESG-focused funds in 2021, inspired by the promise that they can both get rich and save the world. However, they have had the wool pulled over their eyes, argue industry insiders like Fancy who highlight the shortcomings.
He likens ESG ratings to the organic fruit stickers that started appearing in the 1990s, in that neither has been effectively policed. In early 2022, $1trn worth of ESG funds were stripped of their green credentials label. For investors to be part of building and financing a low-carbon economy, Fancy believes the onus first lies with governments to regulate and enforce credible standards.
Here, Opto learns about how the Toronto-based investor came to be one of the leading voices of sustainable investing in asset management, why he’s since called out the industry for greenwashing and how investors can approach the space.
From Silicon Valley to Wall Street
I got into investing almost by accident. After school, I had missed out on a big scholarship. I was a graduate and didn’t know what to do next. Tech and banking were big at the end of the 2000s and because I’d been a self-taught programmer in the early tech era in the 1990s — I even interned on Wall Street at Merrill Lynch, but on the programming side — I went to Silicon Valley as an investment banking analyst at what was formerly known as Credit Suisse First Boston’s technology investment banking group in 2001. Long story short, I learnt to invest when I went into distressed debt investing at MHR Fund Management. There’s a famous corporate raider by the name of Carl Icahn, who started making a lot of noise on ESG earlier this year. His chief investment officer Mark Rachesky left and started a firm and so I started working for him in 2003. At some point, I decided to leave and take off a year to do business school — I had already become the youngest partner at this New York firm.
BlackRock found me because I knew a couple of senior people next to Larry Fink. One of them was someone I’d worked for. He’d been the CEO of the Canada Pension Plan Investment Board. He approached me and said, “this is a really important space, but we want someone who understands both sides of profit and purpose”. I was a vulture investor on one side and on the other side I headed up a tech charity. They wanted someone who’d been on both sides because if you’re credible, you can build from the ground up and know how to translate and merge them. In their view — and I tend to agree with this — it’s very difficult to do both at the same time. There’s no free lunch. It’s a tricky process because you have to understand each independently. There was a thesis emerging where people thought you could do both at the same time. Of course, I drank the Kool-Aid.
Profit and purpose
There weren’t a lot of people in the ESG space with investing backgrounds. That’s partly because it was treated more like a marketing and PR activity, something I only learned when I went in. The other thing, frankly, is good investors cost a lot. The challenge with ESG is that if it’s a marketing PR ploy, then they’re not going to want to pay the same level. I went in because I was passionate about it and I thought this was my chance to do both, and investing was my background. I soon came to realise that ESG investing was not profit and purpose being merged. It’s the same profit model I’ve seen with purpose marketing on top. Done poorly, it’s a placebo that delays us from the actual things that would address these problems.
Stepping back and looking at the job landscape, it’s split into two focus areas. The first is on products like green bonds and ESG ETFs, which is one of the fastest growing categories at BlackRock in terms of asset growth, accounting for more than $500bn of the firm’s $10trn in assets under management in January 2022, and generally has higher fees. The second is process enhancement. The theory was that by integrating ESG considerations into your investment process, you become a ‘better’ investor through what’s known as stakeholder capitalism [which is essentially a business leader’s goal to create long-term value for all their stakeholders — not just shareholders]. I’m not a big believer that aligning your investing with morals is necessarily a good idea, unless it creates some real-world impact.
Fossil fuel divestment
Most sustainable products are based on the theory of divestment. People don’t realise this but technically if I buy an ESG ETF, all it’s doing is tilting a little bit towards higher ESG scores, which generally means that the fund is overweight in tech stocks like Microsoft [MSFT] and underweight in fossil fuels. This led to all these ridiculous assertions that this is good because the pandemic happened, no one travelled and everyone used tech. Tech stocks went up and fossil fuels went down. You’ve seen that reverse in the past six months. It was just correlation, not causation. The idea is that the market is tilting. The theory of change is ultimately the exact same as the theory of divestment, which is to say, ‘if I don’t own this thing, it’ll change something in the world’. The reality is it doesn’t do anything.
I started to realise that a lot of good people were being misled. There’s zero evidence that divestment reduces real-world emissions. We’ve been trying it for decades and it’s wasting energy. People think that it has some impact. It doesn’t. Part of the reason I’ve always known this is because I was a distressed investor. We were the corner of the market that was waiting for the market to crash or people to puke out their assets, who were the sharp-elbowed ones that would buy anything that’s legal and makes money. To me, the idea that you can rely on the market to be ethical is nonsensical. The market doesn’t leave money on the table. If something is legal and makes money, someone’s going to buy that thing.
There are areas of the market where you can create what’s called additionality.
It’s this idea of making something additional happen in the world that wouldn’t have otherwise happened, which is what most people mean when they say impact. There are two areas that are interesting and need to grow. One is private, climate tech VC-type firms. These will provide primary funding — secondary shares trading hands doesn’t really do much — for an innovator. That’s very different to all the public markets ESG stuff, which, unfortunately, is 90% of the products. The second is activist investing. Investors can start a conversation and fight management teams to push for a change that wouldn’t have otherwise happened.
Investing in ESG stocks and funds
There are areas of ESG where there is a strong sustainability thesis. I don’t think it’s through these public market ESG funds because they’re usually just taking the same thing and painting it green. But there are areas where consumer interests can drive sustainable causes. There are certain consumer-facing brands that are quite exposed. For example, a company that sells yoga clothing in California is probably going to have a good ESG profile because their customer base is focused on that. That’s not always the case. There are areas of the market where there are pure play companies like Ørsted [ORSTED.CO], [which is a Danish renewable energy company that is also the world’s largest developer of offshore wind power]. The challenge with a lot of the green companies is that you have to look at buying them relative to their valuation [because some are overvalued financially]. If it is trading at 100 times cash flow instead of 10 times cash flow, no matter how much you like it and think it’s good for the world it may not be a sound investment.
I look for investments where values translate into value. One of the interesting dichotomies I found is that space between value and values. Value is objective — profit margins and trading at certain multiple values. [But] values change from person to person. My investment philosophy is very value oriented. The way I learnt to invest was by making sure the downside is protected — it’ s the most important thing. If I buy a stock for $10 and I believe that in the worst-case scenario it’s worth $7 or $8, either because it has strong and stable cash flows even in a downturn or because the underlying asset value is worth at least that much in a fire sale to a strategic acquirer, then I know my downside risk is largely mitigated. From there, the rest is upside. You might lose some of the crazy get-rich-quick investments, like when crypto goes up 500% in a few days, but not all returns are created equal. The first thing I learnt in banking is that we should not talk about return, you’ve got to have a risk-adjusted return.
During the market downturn, there’s going to be a temporary period where it’s going to be very volatile and bad. I would be very defensive in the near term, but in the medium term when asset prices go down or are cheaper, you might be at the beginning of a new era. When it bottoms out, there will be some interesting sustainable investment opportunities to get behind companies that are building the future we need.
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