Whatever Happened to ESG?

ESG (Environmental, Social, and Governance) investments were the “hot” new thing in recent years. Investopedia defines ESG investing as referring to “a set of standards for a company’s behavior used by socially conscious investors to screen potential investments.”

Supporters of ESG investing claim it improves customer satisfaction and loyalty, reduces the chance of supply disruptions, enhances hiring and retention, and helps increase the stock price by adding ESG investment funds to the list of potential investors.

These claims may or may not be true. As the saying goes, “it’s complicated.”

But even those skeptical of ESG who focus their own efforts on operational efficiency and working capital, will find common ground with another claimed benefit for manufacturers investing in it — reduced waste. This can include implementing scrap programs in various metals categories, for example.

In other instances, reduced waste might involve using supply chain risk tracking solutions that closely monitor weather forecasts on specific logistics routes. This avoids the need for costly refrigerated containers for temperature-controlled goods if forecasts can predict with a high degree of certainty that the goods will not pass through extreme heat or cold. Thus, the carbon footprint within a supply chain is reduced by avoiding the use of energy for climate-controlled shipments, while also lowering the cost of shipping a container.

Programs like these are clearly a “win” for everyone.

However, much of the ESG requirements for manufacturers have felt “compelled” in recent years — a new tax on production, if you will.

Why? In practice, an investor (such as a mutual fund investing on your behalf within an IRA) subscribing to an ESG investing philosophy would prioritize companies scoring high on ESG criteria. For example, an oil and gas company not actively working to “decarbonize” its holdings would score poorly on ESG investment screening criteria, leading investors who favor these metrics to look elsewhere.

Consequently, that “ESG-friendly” large cap stock then often rely on its suppliers to track criteria of their own and implement these practices too (since it’s easier to force suppliers to make most of the investments!)

This is why as a compliance trend, ESG is sometimes important even for smaller manufacturers to understand because often larger customers (e.g., automotive or defense OEMs) need to report on carbon traceability and other criteria in their supply chain, and this responsibility “rolls down” to smaller suppliers.

Besides carbon tracking, other criteria larger manufacturers are increasingly having smaller suppliers attest to practices on, based on “codes of conduct,” include labor practices, human rights, anti-corruption/anti-money laundering, environmental impact, waste management, and financial inclusion.

Additionally, whether companies hire and promote enough “desirable candidates” is a part of these programs. The issue is that many of these “Diversity, Equity, and Inclusion” programs often blatantly violate the US Civil Rights Act and employment laws because proactive discrimination in favor of one party that negatively benefits another is illegal, according to the most recent Supreme Court ruling on the subject.

Ultimately, whether you agree with ESG investing and reporting criteria or not, one thing is clear: US investors are beginning to look the other way, even on a net basis pulling their money from funds which consider ESG criteria in recent quarters. In fact, according to Morningstar and the Financial Times, investors pulled roughly $10B from such funds in North America in 2023 (European investors added over $75B).

The Financial Times suggests that in the US, “Red-state treasurers [have] blacklisted big financial groups including BlackRock, Goldman Sachs, State Street, and Wells Fargo. Some state legislatures, including Florida, Kansas, and Idaho, have passed laws that ban or limit the consideration of ESG.”

Specifically, “Eighteen states have adopted some kind of anti-ESG legislation. Some of the laws ban ‘discrimination’ against companies that sell fossil fuels and guns, others order state pension funds not to consider environmental and social factors while investing.”

Part of the challenge, these detractors suggest, is that ESG is a political game. For example, Tesla is not included in the S&P 500 ESG index, yet Exxon Mobil is because of specific program investments it has made.

Ultimately, whether ESG is on the way out (or not) for US manufacturers is the question at hand in 2024. Our advice: do only what is required today and minimize investments to meet customer (and shareholder) requirements given the uncertainty as to what will be required in the future.