Is top fund selection advice nonsense? More: BlackRock’s ESG Pickle

High stakes

Should your mutual fund managers invest their own money in their funds?

Popular opinion says they should. As we’ve seen here, this demonstrates that a manager’s interests are aligned with those of his investors and gives clients the cold comfort of knowing that if the fund is underperforming, then at least the manager suffers as well.

Managers who invest heavily in their funds, unsurprisingly, tout the benefits to clients and the press, and Morningstar has worked to show that the amount of money a manager has in their fund can be a good predictor of future returns. .

But not everyone agrees that managers with a lot of their own funds are necessarily a good thing. In a recent interview on Citywire’s Mistakes Were Made podcast (listen here!), Harding Loevner VP Simon Hallett takes the other side.

He notes that senior analysts and fund managers typically have equity in companies they already work for, which gives them market exposure and compensation based on their company’s ability to generate alpha. . Additionally, he argues, a manager who has a high percentage of his net worth in his own fund might be likely to make more emotional and risk-averse decisions rather than cold and objective ones. Hallett says:

To tell a portfolio manager that with his personal wealth he must invest in the fund he manages, I think that would be irrational. He wouldn’t be diverse at all, and he would personally find himself in an extremely risky position, and we know that when people are overexposed they tend to become risk averse, and I think that would actually hamper the ability to a portfolio manager to manage the portfolio well.

Hallett’s argument highlights an interesting point: the diversification of managers. Intuitively, it seems fair for managers to have a skin in the game, but maybe it’s a more nuanced situation. When managing a fund that could be part of a diversified portfolio (large caps and US bonds, etc.), it makes sense that they have a large chunk of their money in the fund. But when they manage more niche strategies (such as single-sector stocks) or strategies (short-term bonds, money market funds), a huge holding could suggest – to Hallett’s point – that managers are using the fund differently. of their investors. and so the interests may not be perfectly aligned. Alternatively, it could mean that they are insanely wealthy and possibly overpaid for what they do, which is also not ideal for investors!

Smart and Whimsical

In a series of widely read articles on Medium published earlier this year, Tariq Fancy, the former CIO for sustainability investing for BlackRock, criticized ESG investing on many grounds. He said ESG initiatives are usually hype for businesses and institutional investors, and that sustainable investing can actually make society worse if it convinces people that the government doesn’t need to step in to make it worse. create and implement policies that will slow climate change.

He also tells the interesting story of being blasted on BlackRock’s private jet:

Asked by a Swiss client on a thoughtful question about how these investment vehicles actually contribute to the fight against climate change, I explained how the strong growth of these products could, in theory, find a way to increase indirectly the financing costs for companies that emit more carbon, by encouraging them to reduce emissions. “But haven’t you seen the talking points?” »Insisted [a fellow BlackRock exec], referring to a set of overly simplified bullets [which] clearly expressed their point of view: the key to selling the product was to keep it simple, even if it meant obscuring its direct contribution to the fight against climate change, which was always difficult to explain and at best a little uncertain.

The chips seem to have changed. Speaking at last week’s Carson Excell conference, Lukas Smart, Head of US iShares Sustainable and Factors Product Segments at BlackRock, was quick to explain clearly how ESG investing is changing the world.

“When you stop and think about it, it’s very simple,” the beautiful movie star and aptly named Smart said. “It’s about changing the weighted average cost of capital. As more and more people seek sustainable investments, projects and businesses seen as sustainable will benefit from an easier pool of money, reducing the share of the profits they have to pay to those who actually give up the capital. .

It’s a common view of ESG investing, dating back to the days when we had to spell the acronym when first used (by now everyone knows it’s abbreviated as Expensive Salve for Guilt). But in a way, it’s radically honest to hear BlackRock. The simple truth, pointed out in a 2017 essay by Cliff Asness named after an underrated song by Paul Simon, is that the cost of capital is the same as the return on capital (a term is seen from the perspective of the company, while the other is seen from an investor’s point of view). So of course, if companies pay less to grantors of capital, then the investors who grant that capital are going to receive less – right?

This is not the case, we learned towards the end of the panel. “You’re not giving up anything,” Smart said later in the conversation in Las Vegas, in response to a question from a skeptical returns advisor. “The question is, do you actually get something… You actually have a recipe for outperformance.”

Businesses pay less money and investors get more. Can both statements be true?

Or is it just that BlackRock is getting more of everything – more power to influence companies and more money investors would be willing to shell out if their money was managed according to a standard index?

Direct hits

You may have seen the headlines this week that PGIM Investments has become the latest major asset manager to buy a small company specializing in today’s hot ticket: direct indexing.

According to these stories, PGIM joined the ranks of Morgan Stanley, BlackRock, Vanguard and Franklin to take over such a business.

Except no.

The company PGIM bought – Green Harvest Asset Management – offers custom SMAs that offset gains against losses to manage taxes, the same end result as many companies that do direct indexing. But it does so by managing ETF portfolios rather than the underlying stocks and bonds that make up an index. It is therefore at best an indirect indexation.

By no means worse, just not the same.

To (sort of) defend those headlines, they were just following the line of the press release announcing the deal. It just goes to show that in journalism, like investing, a little bit of due diligence can go a long way.

Agree? To disagree? Let us know what you think – email Alex Rosenberg at [email protected] or Alex Steger at [email protected]

Martin E. Berry