Readers may have noticed our persistent focus on ESG (Environmental, Social, Governance) investing. Do not expect our interest in this subject to subside, just as you should not expect the ESG movement itself to disappear overnight (even if it potentially tries to rebrand itself).

ESG is the corporate world’s version of wokeness—a loose collection of beliefs, attitudes and political agendas that seem consistently at odds with the economic welfare and cultural habits of ordinary American citizens.

Like wokeness, there is no central authority issuing decrees. Rather, ESG flows from a patchwork of likeminded voices (usually operating in tight coordination with the European Union or the United Nations) that generate various policy opinions. These opinions are then presented as the consensus of informed perspective.

The end result of almost all ESG exercises is usually some kind of scoring system, which fund managers are expected to apply, in lieu of their own judgment, as they decide which stocks to buy or not buy. Companies that generally promote the ESG community’s preferred policies are favored, while companies that do not are effectively cancelled.

Finance meets cancel culture

While this may sound a lot like financial censorship, it is strategically framed as risk management. Fund managers are advised to avoid certain politically incorrect stocks because they involve ESG risks (or, as the ESG consulting groups like to say, “controversies.”)

These groups will lead you to believe that ESG is not actually a political exercise in picking winners and losers. Instead, it’s a risk management practice that simply helps fund managers avoid the risks associated with certain political perspectives that other people seem to have.

Curiously, the ESG controversies that get flagged as cause for concern always seem to align with the highest priorities of the global political left. We had an eye-opening experience, when in the course of researching Caterpillar (CAT) a few years ago, we discovered that a widely used ESG rating service was penalizing CAT for “controversies” associated with its sale of construction equipment in Israel.

Fund managers were effectively being pressured to avoid the shares of an important American industrial company because it sold equipment within another advanced democracy that is an American ally. The mere act of selling equipment in Israel created “financial risk” because it was “controversial.”

ESG is inherently anti-American

ESG is antithetical to classical liberalism. Classical liberalism (not to be confused with the current use of the term “liberal” as a way of describing left-wing thinking) is the philosophical basis of the American experiment. Individual liberties, property rights, the Constitution—Washington, Jefferson, and Franklin—to a man, every Founding Father—they were all classical liberals.

The United States was created to implement the philosophical concepts of the great thinkers of the Enlightenment—from Adam Smith to John Locke to Voltaire. The Founding Fathers not only studied these thinkers, they were themselves great contributors to this intellectual movement, which was grounded in ideas like liberty, equality, sovereignty, privacy and God-given rights.

The statesman who should attempt to direct private people in what manner they ought to employ their capitals, would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate whatever, and which would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it. - Adam Smith, The Wealth of Nations

The very premise of ESG, which functions as an externally imposed ideological system that sits upon what should be independent business decision-making, is by its nature a rejection of individual property rights. It seeks to take control of a business from its rightful owner by subordinating his financial interests to greater societal objectives.

ESG is also a method of conducting industrial policy without the involvement of political bodies that have been empowered through democratic processes. It is economic governance by unelected elites. Their point of entry into the process is at the very top of the food chain, the institutional asset managers that control about 80% of the U.S. stock market.

These elites are able to get away with this because they masquerade as impartial risk managers. The asset management industry plays along with the charade because they are pressured to do so by regulators and highly influential clients (like massive sovereign wealth funds). The asset managers also benefit in certain ways from the additional layer of complexity and have incentives to support it, including higher fees.

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The rise of ESG has been simultaneous with the rise of DEI, another illiberal political movement that takes aim at our system of individual rights and puts power in the hands of unelected elites. (Fortunately, these anti-American ideologies are usually given three-letter acronyms, making them easy to spot.)

Ibram X. Kendi popularized Critical Race Theory (CRT), which (as we discussed in 76report Issue #1) is the philosophy that underpins the Diversity, Equity and Inclusion (DEI) movement. Kendi’s best-selling How to Be an Antiracist came out in August 2019, just in time for the rise of the BLM movement following George Floyd’s death in early 2020.

While CRT has been around for decades, Kendi simplified it for a mass audience and breathed life into the inverted understanding of racism, inspired by CRT, that now defines DEI initiatives.

We used to think of racism as judging someone or treating someone differently on the basis of race. Applying CRT principles, Kendi redefined racism as failing to judge or treat people differently on the basis of race. Kendi seeks to rehabilitate racial discrimination as a good thing and even wants to amend the Constitution to create an all-powerful enforcement mechanism for it.

Since the 1960s, racist power has commandeered the term “racial discrimination,” transforming the act of discriminating on the basis of race into an inherently racist act. But if racial discrimination is defined as treating, considering, or making a distinction in favor or against an individual based on that person’s race, then racial discrimination is not inherently racist. The defining question is whether the discrimination is creating equity or inequity. If discrimination is creating equity, then it is antiracist. If discrimination is creating inequity, then it is racist… The only remedy to racist discrimination is antiracist discrimination. The only remedy to past discrimination is present discrimination. The only remedy to present discrimination is future discrimination. - Ibram X. Kendi, How to Be an Antiracist

“Equity” is really the key concept of the DEI movement—sandwiched in between the relatively more innocuous Diversity and Inclusion concepts, which are arguably there just to make disagreement with DEI more difficult.

(If someone challenges DEI because he does not like how equity mangles the traditional understanding of human equality, DEI advocates are usually ready to pounce: “So you’re against diversity, you monster!”)

The ideology of equity replaces equal rights with equal outcomes, just as ESG replaces property rights with a set of desired social and political outcomes. Given these similarities, it’s not a surprise that DEI itself has actually become a core pillar of the ESG movement.

If you, like us, have an affinity for traditional capitalism—and the idea that actors within our economy should stay within their lane, whether as business owners, managers, customers or regulators, and that people should be judged in the workplace on the basis of merit—being an investor in the 2020s presents a series of challenges. We highlight two major issues:

Corporate wokeness destroys value

First, there is the problem of companies becoming so completely captured by the various dogmas of the ESG movement (from climate change to racial equity to gender fluidity) that they actually bring harm to their own businesses and destroy shareholder value. Disney (DIS), Anheuser-Busch InBev (BUD) and Target (TGT) have all been high-profile examples. Each of these stocks has substantially underperformed the S&P 500 Index over the past three years.

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Many companies are making bad business decisions as they fall prey to ESG and related woke pressures to advance political agendas that undermine their own profitability. In the cases of DIS, BUD and TGT, the issue is that they have alienated their own customers.

Although the actions of DIS, BUD and TGT were impossible not to see, the impacts of woke business practices are not always easy to detect. In many industries, like the airline industry, merit-based hiring approaches are being replaced by equity initiatives. It is hard to measure what sort of negative effect this may be having on operational performance, although common sense would suggest it cannot be helpful.

Corporate wokeness is morally repulsive

The second major problem of investing in the era of woke capitalism is the way it alienates people who may have traditional beliefs about human equality, do not buy into climate hysteria and hold patriotic attitudes. These investors dislike being owners of companies that appear to be operating in direct conflict with their own values and priorities.

The truth is almost every publicly traded company out there is pursuing an ESG strategy. Often, this is out of necessity; one gets the feeling from many companies, especially those based in the heartland, that they are just going through the required motions. But almost every company has embraced some form of DEI and is engaging in what an objective observer might describe as woke behavior.

Wokeness is pervasive now across Corporate America. While some are clearly worse than others, basically every company is at least a little woke.

So how do we respond to this unfortunate situation, in a manner that protects our pocketbooks as well as our self-respect?

(1) Don’t opt-out of the system

Tempting as it may be to say, “forget about it, I’m out,” and to just invest in bonds, or gold, or Bitcoin, or physical real estate, this isn’t a helpful solution. Corporate America may at the moment be dominated by the woke mindset and engaging in many practices that we don’t like and are even self-defeating. Yet Corporate America remains a tremendous engine of prosperity and value creation.

Antiwoke investors may be tempted to boycott American companies entirely. This would of course mirror the strategy of the ESG movement and its even more twisted ideological cousin, the anti-Israel Boycott, Divestment and Sanctions (BDS) movement. But this will mainly just bring financial harm to the individuals engaged in the boycott. The opportunity cost is too great.

To make matters worse, a blanket boycott of U.S. stocks leaves all the potential upside of the American stock market to the people who endorse woke politics. The woke will simply get richer faster than the non-woke. That is not desirable.

(2) Invest selectively

While basically every listed company is probably doing something worth criticizing, there is a wide range of behavior. This potentially requires a stock-by-stock approach to portfolio construction, rather than a broad-based fund approach.

When we think about which companies to include in our Model Portfolios, we give a great deal of consideration to management and company culture. We do this because we want companies that are laser-focused on creating shareholder value, not because we are looking to promote companies that align with our own personal beliefs per se. Any company that is elevating political agendas over long-term financial performance is unlikely to be a good investment.

Taking a page from the ESG community, as we choose stocks, we are also mindful of the enormous risks of political backlash in the other direction. These are the sort of political and social risks that the ESG people never seem to talk about (and in fact are often responsible for creating).

There were no ESG ratings reports that flagged how Bud Light was on the precipice of implosion. Fund managers today are so brainwashed by the ESG perspective that they miss the obvious risks associated with radical business moves that simply won’t “play in Peoria.”

With both corporate executives and institutional money managers blinded by ESG pressures and incentives, woke stupidity is a genuine risk factor that needs our full attention as we pick stocks.

If you do choose to invest through funds, you can familiarize yourself with their proxy voting policies. Vanguard, for example, has adopted a more neutral approach than other managers on ESG questions. Strive Asset Management operates with a proxy voting model that emphasizes shareholder value over the “stakeholder” approach championed by the ESG movement. (We have absolutely no business relationship with either firm.)

(3) Accept the world as it is

ESG is among other things part of a broader “decarbonization” movement that is changing the global economy. Whether or not one agrees with any or all of the policies and government initiatives associated with this agenda, it is driving the flow of capital in many industries. This creates risks as well as opportunities across the board.

Many industrial companies, for example, stand to benefit, sometimes indirectly, from these changes as they sell material or equipment into very large “green” infrastructure projects. Paradoxically, many companies that operate in the fossil fuel or commodity sectors stand to benefit from the combination of greater demand for their products, tighter supplies and reduced competition.

As investors, we should not penalize companies for pursuing real business opportunities as they present themselves, even if we do not entirely agree with the underlying policies that create those opportunities. Don’t hate the player, hate the game.

(4) Find other outlets to express yourself

While everyone has to find a way to sleep at night, the main focus of an investor should be pursuing financial upside while managing risk. ESG is fundamentally flawed because it mixes politics and business.

There are ways to engage with political or social causes that do not compromise one’s brokerage account. Having a larger brokerage account may give one more ability to have a political or social impact through political donations or other endeavors.

What I am describing now is a plan and a hope for the long term —the march of freedom and democracy which will leave Marxism-Leninism on the ash-heap of history as it has left other tyrannies which stifle the freedom and muzzle the self-expression of the people. - Ronald Reagan, addressing British Parliament, 1982

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ESG (or stakeholder capitalism, or woke capitalism, or whatever you want to call it) is not capitalism at all. It is an attack on capitalism and on property rights. It is a form of corporatism that disenfranchises both property owners and voters. It is a shift of political and economic power to unelected elites who claim to know better. The world has seen this movie before.

On the bright side, there has been a great deal of resistance to it, which of course needs to be sustained (and we intend to do our part). This resistance has come from politicians, especially at the state level. It has also come from the private sector, as investors themselves are starting to see the movement for what it really is.

Bad ideas can stick around for a while but generally don’t have long-term staying power. With the forced resignations of two Ivy League university Presidents, we are hopefully starting to see the wheels come off the DEI movement. One gets the feeling that ESG, like other forms of collectivist nonsense, is ultimately headed for Reagan’s ash-heap.

How to Be an Antiwoke Investor

As investors, for both financial and ethical reasons, we should stay clear of the very worst of the woke companies—but we should not make the perfect the enemy of the good.  We should carefully build our own portfolio of individual securities that meet our standards. When we invest in funds, we should choose managers with proxy voting practices that we find acceptable. Most of all, we should keep our eyes on the prize—generating good long-term compounded after-tax returns.

If we meet with success, we can use some of our gains to contribute to candidates and causes that are leading the charge against the woke takeover of the American economy. As investors and consumers, we can do our part to distance ourselves from the worst offenders. But the war on corporate wokeness ultimately has to be won in the political arena.

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