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According to Deloitte, global ESG assets under professional management could be worth $80 trillion by 2024. But this growth in popularity combined with a global energy crisis is facing the sector with growing polarization. Critics worry that capital dedicated to ESG investing favors one value system over others.
Lauren Taylor Wolfe co-founded Impactive Capital, an activist investment management firm focused on long-term ESG investing. She spoke to CNBC’s Delivering Alpha newsletter to discuss why she thinks ESG investment bans might be too risky and how understanding environmental, social and governance risks is ultimately good for businesses.
(The following has been edited for length and clarity. See above for the full video.)
Leslie Picker: Are you surprised that ESG has become one of the most controversial areas in finance in recent months?
Lauren Taylor Wolfe: No I’m not. Look, ESG without returns just isn’t sustainable. Hundreds of billions of dollars have been allocated in the United States alone to ESG-specific ETFs and actively managed mutual funds. Globally, there have been trillions[s] allocated. And like all things trendy, sometimes the pendulum swings too far in one direction, and so now there’s been a lot of scrutiny on a lot of ESG products. But again, not all ESG products are created equal. As I mentioned before, without feedback, these products simply won’t succeed. Now, at Impactive, we’re taking a different approach. And we’ve proven that you don’t have to sacrifice returns to get a good, strong ESG improvement. We are thinking of two things: first, can you solve a business problem with an ESG solution? And second, can this solution generate profitability and returns? We’ve seen a lot of resistance from some politicians and I think it’s just too risky. Understanding environmental risks and social risks is simply good fundamental analysis and it’s just plain good investment. So for states, for example, to ban this type of investment, I think it’s just too risky. It’s bad for retirees, it’s bad for voters, because it’s just a good way to analyze a business over the long term.
Picker: I think at the heart of the problem is this idea that ESG and profitability are mutually exclusive. Do you think there can be ESG improvements that immediately drive margin expansion? A lot of people say, “Oh, well, in the long run, it’ll be much better for the business.” If you are a long-term fossil fuel producer, the transition to green energy will be better for your survival. But if you are a retiree or one of the investors who need a shorter time horizon to earn, achieve your goals on a yearly basis, you somehow need a faster turnaround time . Is it a sort of question of duration in terms of the ability to generate this profitability?
Taylor Wolfe: We focus on two areas, ESG impact and capital allocation impact. The impact of capital allocation is about, “oh, you should sell the segment, do this leveraged recap, you should make this acquisition.” This can have an immediate impact on yields. Environmental, social and governance changes, for the most part, are cumulative in nature and, in fact, take longer to register in returns. But pensioners, as an example, they have – this capital is almost eternal. And so, you know, the market itself, I think, has been plagued by short-termism. We have too many managers, CEOs and boards focused on hitting their quarterly or annual numbers and we believe there is a real opportunity to focus on long-term returns, IRRs at long term. In fact, at Impactive, we underwrite three to five year TRIs because that’s where the real returns can be had. So you have to be able to look beyond a year… We have a car company, a car dealership, whose most valuable segment is the parts and service segment. It generates two-thirds of the company’s EBITDA, and industry-wide there was a labor shortage. And so, we told them, you’re entirely overlooking one pool of candidates, and that’s women. You’re not attracting women to become mechanics, but they’re dominating the industry as customers spending over $200 billion a year on auto maintenance and retail. And so, of course, they added mechanics. Over the past two years, they’ve doubled the size of their female mechanics. And we convinced them, my goodness, if you invest in benefits, like maternity leave or flexible working week, by simply adding women to mechanical strength, you can increase your use by 50% to 55% while your competitors are stuck at 50%. [percent]. And that will result in – because it’s the most profitable business that has the highest multiple – it could increase your overall business value by 20%. And so I’m using this example to show you that it’s going to take time to go from one or two percent, where women sit as a percentage of mechanics in the workforce, from one or two percent, to where I think it can go 10 percent. And it can have a huge impact on the overall value of the business. It doesn’t happen overnight, but it can have a huge long-term impact on that company’s overall returns.
Picker: That brings up a very good point – this idea that maybe it requires a bit more creativity and some sort of new way of thinking, as opposed to what has been done historically. What do you think of the initial cost of investing in something like this and investing in this transition, and how investors should be thinking just about deploying capital in order to make this transition work maybe from the start, and the expectations as to how this ultimately ensues?
Taylor Wolfe: It will depend, right? If you’re encouraging a company to invest in a giant, new, fabulous facility for wind turbines, or wind and solar capacity, or even new chips, that’s going to be a huge upfront expense. But it will generate several decades of returns as we see the age-old tailwinds coming from government spending on renewables or consumer preferences and spending on renewables. For something like Asbury, where they’re investing in paid maternity leave, they’re adding women’s bathrooms to their parts and services facilities – they’re up to, I think, about 70% of the parts and services facilities of services have bathrooms for women. Those are smaller dollars, right? So I think that expense will almost immediately be accretive because as they hire more mechanics, they generate higher revenue for the company. But to answer your question directly, it really depends. The larger expenditures where you invest in renewable energy and very capital-intensive environmental products, which obviously will require a huge and much larger capital outlay than some of these less asset-based initiatives, like hiring more female mechanics, training them, and adding them to your workforce so you can accelerate your most profitable segment from mid-single-digit to double-digit growth — which pays off almost immediate.
Picker: Yeah, something as small as adding a women’s restroom. It’s something you don’t think about, but it obviously makes a big difference. I also want to ask you how this all fits into the macro context, because historically some people and some critics have said, “Oh, well, ESG. It’s a bull market phenomenon. And that’s really nice to have is something you can benefit from when the economy is doing well, when the markets are doing well.” And that’s part of why we’ve seen so much capital flow into this area which has since reversed, at least in many traditional publicly traded ESG companies. But now we’re facing inflation, we’re facing higher interest rates, the prospect of a potential recession, are you worried that ESG will be pushed further into the background in the meeting, in light of some of these macroeconomic challenges?
Taylor Wolfe: I don’t think they will. I don’t think we are going back to the days when the pursuit of profit was at the expense of the environment, it is towards our society that we are heading. And I think smart ESG initiatives are just good business. It makes businesses more competitive, more profitable and more valuable in the long run. And we’ve studied that, okay, we’re looking at – if you look at millennials and gen Z, they care about how they spend their two most important assets, their money and their time, and they do even more so in a way that aligns with their value system. What does that mean? These are the same people who are your employees, your customers, your shareholders. And as a company and a board think about it, to the extent that you can attract and retain more loyal customers, more loyal employees, more loyal shareholders, you lower your customer acquisition costs, you lower your human capital costs and you reduce your overall cost of capital. It makes your business more competitive, which makes it more profitable, which makes it more valuable in the long run. And so sure, in this type of environment where we have a rising inflation backdrop, you know, rates are going up, we may be in a recession or the recession may be really, you know, in a few quarters, I think companies are thinking about how can they, you know, track prices, how can they strengthen the moat around their business. And having a more sustainable solution will lead to price inelasticity, which will protect their business and profitability.