Week 26: Radical honesty with Tariq Fancy

Dear all, 

How toxic has the “ESG” label become? BlackRock Inc. Chief Executive Officer Larry Fink spent years positioning his firm as leader in ESG investing, only to face outcries from Republican politicians who pulled more than $3 billion in state funds from his firm. On Sunday, Fink said he’s retiring the “weaponized” term since it has been “misused by the far left and the far right.”

Fund managers have grown weary of the growing political scorn aimed at the environmental, social and governance label. So many have decided to call their funds something else.

Thematic exchange-traded funds – ones that focus on stocks around a particular subject – have taken over as the most common way to launch products in areas like clean energy or gender diversity.

Even as some fund managers rebrand their ESG-related products, others are urging proponents to push back against those who decry “woke capitalism.” And their opposite offerings — anti-ESG funds — have largely failed to draw major investor interest. 

I recently had the pleasure of speaking with Tariq Fancy. We covered many topics, including why, at the core, we need to be far more honest about where we are.

Tariq has spent a career on the extremes of profit and purpose, most of it in finance, on the profit side of the spectrum as a distressed investor, and then in private equity and hedge fund investing. Tariq also spent time on sabbatical building a nonprofit education project, Rumie. It's used by people to learn on mobile phones around the world. He has also worked in sustainable and impact oriented investing, most recently as Blackrock Chief Investment Officer for sustainable investing.

This week I share some of the highlights from our conversation. You can listen into the full 30 minute conversation on ESG Radio. 

Tariq, ESG seems to be a concept or approach to investing that is utterly failing right now. What are your thoughts?

The ESG space is at an interesting inflection point. There are a lot of useful things that have been created, let's call them the ingredients; increasing and improving data; being able to measure environmental and social characteristics; standardisation of the frameworks of how that data is reported that enable better comparisons. But I don't think that they have necessarily been used to bake the right dishes that we need right now. 

Encouragingly, you have a lot of really passionate people who have joined the ESG space, particularly young people who are very motivated. Those are all great things.

Where they sometimes fall apart is that they get combined into products that imply that there's real-world impact that doesn't exist. That concerns me. It can be dishonest to the investor who's paying higher fees to believe in their current impact. They also act as a placebo - because they convince people that there's an easy solution, like buying a low-carbon ETF that means that we don't need more substantive changes. 

There is a narrative that is prominent across the world that ‘green growth’ can be combined with the capitalist model in a sustainable way. Do you think it's possible?

The fundamental challenge is that a lot of things that would push us toward a more sustainable future are inherently expensive to do. 

They are more expensive business models for a variety of reasons. You're no longer taking advantage of the fact that you can exploit the environment in the short term, in a way that's good for private profit but is not good for the long-term public interest. 

I liken it to a sports game where there's a competition going on, and the players will score more points and win more games by playing dirty. We need to close those loopholes and make it harder for players to cheat. 

If you don't have referees come in, you put business people in a tough position. Many of them are individuals in a bigger system, where the system’s incentives and structures define the limits of what they're able to do - and what they cannot usually do - to give up profit to do the right thing, because it's not their money. They're fiduciaries to shareholders or investors.

Expecting big corporates to level the playing field is like believing in Santa Claus

We know enough to know that it doesn't work. It’s not structured in a way that should work. The one thing that really changes behaviour and financial markets is changing incentives - and that is one thing we don’t do. In fact, it's worse, this expectation [of corporates levelling the playing field] distracts us from the fact that we're not changing incentives. Fundamentally, it creates a real risk of delaying action.

Elon Musk has expressed concern about ESG, citing examples where tobacco companies or Exxon receive better ratings than Tesla. Do you believe there is some validity to his criticism?

The biggest challenge here, which Elon Musk has touched on, is that there is no good reason that you would merge environmental, social and governance metrics into a single metric. This is an important point. 

If you're an investor you need data to make a good investment. You would never merge a whole bunch of indicators (that may all be relevant). You might think the gender policies that a company has are important; their emissions are important; their governance criteria, important. They all may be important, but there's absolutely no good reason an investor would merge all of that stuff into a single score of uncertain weighting. 

The fact that it's being done shows that it didn't begin with the investing world. It began with the marketing folks who saw an opportunity to come up with a single score that might be useful to a virtuous investor, even though it merges all kinds of things. And as Musk pointed out, it puts the EU against the US at different points.

What is your view on the lack of government action in addressing sustainability issues? What is your view on what is happening in the US right now?

ESG has become a political bashing tool. There's an instant reaction from the ESG community that, ‘Oh, the US Republicans are bad people'. They're attacking something beautiful because it has the words environmental and social in it. 

I don't want to defend the Republicans, but I'd make an important point. The Republicans only jumped into the fray about a year after the greenwashing backlash occurred, or began, really from ex-insiders talking about it. So, it's worth people asking an important question, which is how was it possible that the party of the left in the US - arguably the party fighting climate change - had no problem with Wall Street greenwashing the public? How is it possible that the Republicans are the only ones that complained about it? It's covered by a lot of noise and political theatre, like anything in US politics these days. It kind of looks like WWF wrestling from the 90s. 

Generally speaking, ESG funds have been marketed to progressives; it was almost a segmentation strategy. If you look into the so-called investment theses underneath it, you find that the ESG funds always align with progressive interests, and where the E can be sort of objective, the S is a little bit less objective. 

In a lot of cases, it seemed like the thesis of an ESG fund was always going to be that diversity is better for returns. I believe in diversity, equity, and inclusion, from a social perspective, I think is very important. However, it's not always clear to me that there is an instant return potential from adding diversity to your board. But those are the things that an ESG fund would never have - having all white guys and saying that Florida is great - even if the data said the opposite. I'm not saying it did say that. But if it did, there's no way that an ESG fund would incorporate that because really they were designed to target progressives. 

That's why it's important to understand that the Republican pushback is somewhat in reaction to this. They're pushing anti-ESG funds, and the anti-ESG funds are pro-carbon emissions. It looks to me like a polarisation of commoditized products that is occurring across the US today. Here are some ETFs for Republicans, and here are some for Democrats. I'm not sure that the world changes at all, as a result.

ESG's current landscape raises questions about the prevalence of green ‘wishing’ without any accountability for the costs of necessary change. Are such tendencies dominating the ESG world? Will promises and commitments translate into genuine impact and change in the future?

It will take time in the US because of the extent to which their political system is seized by, frankly, moneyed interests. 

It's very difficult to get a lot done if a dirty player has an unlimited ability to pay the refs indirectly behind the scenes to keep the loopholes open. So, the US, I'm a bit concerned with where they are. 

I think in Europe, you do get change. But an important thing to remember is that there's a difference between regulating the financial services industry and fund flows on one hand, and regulating the real economy and business activity on the other. 

Imagine if you say factories can't pollute anymore. If you do, you're going to pay a fine for that. That's a systemic regulation that's across the real economy. What will happen is that capital will flow less to polluting activities, by definition, because they're now less profitable. More capital will start to find its way to funding alternatives that are clean, because there's a greater impetus and greater profit potential, relatively speaking to do that. 

A lot of the focus now is on regulating fund flows and saying this fund is green, and then this other fund isn't green. It's not clear that that actually changes anything in the real world; bifurcating, saying you get a green sticker because you invested in something nice. 

I can’t stress this enough - I used to be a distressed or vulture investor, that’s where I started my career. Our play was that we would be looking in the corners of the market where there was an outsized economic opportunity. A bunch of good people don’t want to do this, fundamentally, they confuse boycott and divestment. If 30% of good people don't want to eat meat or do something that they think creates emissions, you get 30% less demand and 30% fewer emissions. But that's not the way the markets work. If 30% of the market doesn't want to do bad things, doesn't want to invest in oil, but everybody still uses oil, the price of a barrel of oil is exactly what it was the day before them selling. It doesn't change anything, but hands profit potential to whoever does buy. 

You're just bifurcating fund flows, but there's no reason to believe that you're depriving players of capital. Certainly the mechanism, in theory, could have some marginal impact but it is far too slow to solve our problems. If we rely on that, I'm convinced that we'll have political instability and much bigger issues long before that provides a solution to anything.

Emissions are going up, the dirty sectors are changing face, but they're not disappearing. So, what is the solution? What could we do in a different way?

Fundamentally, we need more accountability in business. The thesis of a lot of the leaders of the ESG space, and especially the ones on Wall Street (because they said this explicitly) was that this offers a solution to the fact that the government is perceived to be failing in the eyes of the public on important long term issues. 

In the US, 70% of Americans believe that the economic system is rigged. That's extraordinary, that level of disaffection. You also have the majority of Gen Z and millennials who don't believe in capitalism. It's unprecedented to have all of the younger generations united and say we don't believe in the system, because that can lead to weird political outcomes. 

It’s not like people knew what Brexit meant when they voted for it, or anyone knew what Trump's policies were. You have the leaders of business standing on stage saying, ‘Oh, we've got this right. We have a solution to this problem.’ And every single year Blackrock’s earnings go up and they look great. And the IPCC puts out a report saying we're falling behind on our climate goals.

Looking at developing markets where a transition would make a difference for billions of people - it is not happening. Do you think these markets are hindered by an Anglo-Saxon approach to ESG data and discrimination?

A lot of what's in the S is, whether we like it or not, reflective of the values of society, and that's not objective. 

Having ESG funds evaluating S criteria where there's no clear link to return, and it seems to be more of a social project is going to become very difficult, because people in these markets will say, rightly, that there's no return basis for a lot of this stuff. It seems like a value judgement that really is colonial to be closing on other markets. 

A lot of those emerging markets have oil and gas, it's part of their economy. If we walk in and just say, hey, you should do less based on what we've built, they're going to turn around and say, wait a second, how does this fund speak to our society? How does this speak to our social and cultural context? If it doesn't, are you just depriving us of capital, which is particularly annoying to a lot of them because they say, wait a second, you pulled out all the oil, right? 

Norway has one and a half trillion dollars. They've taken alcohol here, while they're sitting around emerging markets where people are poor, they're darker skinned, and they're going to eat the costs of climate change. You're saying, ‘Oh, but you can't, you were late to the party, you don't get to take that out. And we're not going to budget to do it.’ It's not viewed positively on the receiving end.

How do you view COP28, considering the reports of influence from oil and gas companies and the question of control?

I think we should embrace the fact that COP28 has the chance of looking like reality 

Right now, political lobbying and spending in the US have reached epic proportions. We don't even know how much it is. Because after 2010, the Supreme Court had what's called the Citizens United decision which unlocked unlimited political spending. 

A few years ago, you had an Exxon Mobil lobbyist who was recorded on camera, saying, ‘listen, we just publicly voiced support for a carbon tax for PR reasons, because we know we can block it behind the scenes. Can you imagine? It would be like if the NRA, the National Rifle Association, reached the point where they realise there's no way to defend machine guns being sold to people to take to schools and kill people and so we can't be seen to be defended anymore. And they said, okay, listen, we are going to support banning assault weapons. Then they were caught behind the scenes saying, yeah, we're not going to do that. We were just saying that because we know we still sell guns. So that situation, you look at it, and you think, wait a second, there's the summit. 

One European member of Parliament claimed that ‘oh, COP28 is a big problem, because the chair of an oil and gas company is the chair of COP28 - and the actual line was this ‘listen if you are the foxes, I’m your henhouse.’ 

My response to all of these Western democracies into the Western narrative, which is completely missing the point, is that the fox is deciding the henhouse in Western countries. They're just doing it from behind the scenes. And they're doing it in a way that's dishonest. So that is what's destroying the public's faith and capitalism is destroying the public's faith and democracy. I would go as far as to say that the UAE should turn around and say, wait a second, everybody's using fossil fuels today and we have the lowest cost to extract it. 

We may not like the idea of the chair of an oil company being the head of something. But that is the reality in the globe today. The UAE and other countries are not going to come to the table if we lecture them because they know very well that they don't have to, that's their economy anyway. Our country is the one buying their oil. At some point you need to get past greenwashing to truth even if it's uncomfortable. And the longer we wait, the more we're delaying the substantive and difficult conversations that we need to undertake.

We need to be far more honest about where we are

Right now what we're doing is not working, because every year ESG words and assets all increase, and they increase alongside emissions. That's creating the rift where the young are just reaching the conclusion that this is the best capitalists can provide and capitalism may be the issue, right? We need to get to the heart, the hard work sooner than later. Because otherwise we really do risk the political foundations of our entire system.

You can listen in to the full conversation on ESG Radio.

Have a great ‘honest to the core’ week!

Best regards, 

Sasja