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According to Deloitte, professionally managed global ESG assets could be worth $80 trillion by 2024. But this growing popularity coupled with a global energy crisis means the sector faces increasing polarization. Critics fear that the capital dedicated to ESG investing promotes a value system at the expense of others.
Lauren Taylor Wolfe co-founded Impactive Capital, an activist investment management firm focused on long-term ESG investing. She sat down with CNBC’s Delivering Alpha newsletter to share why she thinks banning ESG investing may be too risky and how understanding environmental, social and governance risks is ultimately good for companies is.
(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 more controversial areas of finance in recent months?
Lauren Taylor Wolfe: No I’m not. Listen, ESG without return just isn’t sustainable. In the US alone, hundreds of billions of dollars have been allocated to ESG-specific ETFs and actively managed mutual funds. It was trillions worldwide[s] allocated. And as with all things trendy, the pendulum sometimes swings too far in one direction, and so many ESG products have now come under scrutiny. But again, not every ESG product is the same. As I mentioned earlier, without returns, these products simply will not thrive. Now at Impactive, we’re taking a different approach. And we’ve proven that you don’t have to sacrifice returns to get good, strong ESG improvement. We’re thinking about two things: First, can you address a business problem with an ESG solution? Second, can this solution increase profitability and returns? We’ve seen a lot of opposition from some politicians and I think it’s just too risky. Understanding environmental and social risks is just good fundamental analysis and just a good investment. So if, for example, states ban this type of investment, I just think it’s too risky. It’s bad for retirees, it’s bad for voters because it’s just a good way to analyze a company over the long term.
Picker: I think 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 lead to margin increases? A lot of people say, “Oh, well, this is going to be a lot better for the company in the long run.” If you’re a long-term fossil fuel producer, transitioning to green energy is better for your survival. But if you’re a retiree or one of those investors that needs a more short-term time horizon to make your mark annually, you’re more likely to need a quick turnaround there. Is it a matter of time in terms of ability to increase that profitability?
Taylor Wolfe: We focus on two areas, the ESG impact and the impact of capital allocation. The impact of capital allocation is something like, “Oh, you should sell the segment, do this leverage recap, you should do this acquisition.” That can have an immediate impact on returns. Environmental, social and governance changes are largely cumulative in nature and actually take longer to feed into returns. But retirees, just for example, they have – this capital is almost eternal. And so, you know, even I think the market has been plagued by short-termism. We have too many managers, CEOs and boards focused on hitting their quarterly or annual results, and we believe there is a real opportunity to focus on long-term returns and long-term IRRs. In fact, at Impactive we write 3-5 year IRRs because that’s where the real returns can be found. So you have to be able to look beyond a year… We have an automobile company, a car dealership, whose most valuable segment is the parts and services segment. It accounts for two-thirds of the company’s EBITDA, and there has been a labor shortage across the industry. And so we told them that you’re completely overlooking one pool of candidates, and they’re women. They don’t attract faithful wives as mechanics, but they dominate the industry with customers spending over $200 billion annually on auto service and auto dealerships. And so they sure added mechanics. In recent years they have doubled the size of their female mechanics. And we got them, my goodness, if you invest in benefits like maternity leave or flexible work weeks, just by adding women to the mechanic squad, you can increase your utilization from 50 percent to 55 percent while your competitors are stuck at 50 [percent]. And it will float – because this is the most profitable business with the highest multiplier – this could add 20 percent to your overall business value. And so I’m using this example to show you that it’s going to take time to go from 1 or 2 percent, where women are the percentage of mechanics in the workforce, to 10, where I think it’s 1 or 2 percent that it can go percent. And that can have a huge impact on the overall company value. It won’t happen overnight, but it can have a huge impact on this company’s overall returns over the long term.
Picker: That brings up a really good point — this idea that it might require a little bit more creativity and a kind of new way of thinking as opposed to what has been done in the past. What are your thoughts on the upfront costs of investing in something like this and investing in this transition and how investors should just think about the use of capital so maybe this transition works up front and what are your expectations of how does this ultimately work?
Taylor Wolfe: It will depend, right? If you’re encouraging a company to invest in a huge new fabulous wind turbine or wind and solar array or even new chips, it’s going to be a huge expense upfront. But it will drive decades-long returns as we see the secular tailwinds coming from government renewable energy spending or consumer preferences and renewable energy spending. For something like Asbury, where they invest in paid maternity leave, they add women’s restrooms to their parts and services facility — they have, I think, about 70% of the parts and service facility women’s restrooms. Those are smaller dollars, right? So, I believe this spending will have a positive impact almost immediately as it will generate higher profit dollars for the company by hiring more mechanics. But to answer your question directly, it will really depend. The bigger expense when you’re investing in renewable energy and environmental products, which is very capital intensive, which obviously has a huge and much larger capital investment than some of these more capital-poor 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 growth to double-digit growth – it pays off almost immediately.
Picker: Yes, something as small as adding women’s restrooms. It’s something you don’t think about, but it obviously makes a big difference. I also want to ask you how all of this fits into the macro backdrop because in the past some people and some critics have said, ‘Oh, well, ESG. This is a bull market phenomenon. It’s something you can take advantage of when the economy is good, when the markets are good.” And that’s partly why we’ve seen so much capital pour into this area, which has since reversed, at least for many traditional ESG public companies. But now we face inflation, we face higher interest rates, possibly the prospect of a recession. Are you concerned that ESG will take a backseat to some of these macro challenges in boardrooms? ?
Taylor Wolfe: I don’t think they will. I don’t think we’re going back to the days when the pursuit of profit at the expense of the environment has fully flourished, our society is where we’re going. And I think smart ESG initiatives are just good business. It makes companies more competitive, more profitable and more valuable in the long term. And we’ve researched that, right, we’re looking at — if you look at Millennials and Gen Z, they care about how they spend their two most important assets, their dollars and their time, and they do it more in a way, consistent with their value system. So what does that mean? These are the same people who are your employees, your customers, your shareholders. And when a company and board of directors think about it, 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 lower your overall cost of capital. This makes your business more competitive, which makes it more profitable, which makes it more valuable in the long run. And so sure, in this kind of environment where we have a background of rising inflation, you know interest rates are going up, we could be in a recession or a recession could actually be, you know, just a few quarters away, think I companies are thinking about how to keep up with pricing, how to strengthen the moat around their business. And a more sustainable solution will encourage price inelasticity, protecting their business and profitability.