I sat down with NYU Professor Aswath Damodaran, the “Dean of Valuation” to discuss ESG. The Professor was an early ESG skeptic. His research validated the work done by Constrained Capital and reaffirmed the opportunity for ESG Orphans and $ORFN. Damodaran highlighted the ruse that is ESG and the false promises and misguided objectives along with hidden costs impacting returns. He concluded that there are costs to ESG and being good which leads to lower returns. You can’t get something for nothing. Goodness has its costs.

Followup Conversation with Professor Damodaran

Mark and the Professor had some post-video conversations that created some instant classic soundbites around nuclear, ESG practitioners “knowing best”, being “good,” and the costs, the current state of ESG and where it’s going, and the elephant in the room that ESG supporters face about telling the truth.

Nuclear and Future Energy

Mark: The EU seems to be going backwards, faces a harsh winter due to their nuclear/ESG stance.

Damodaran: People’s perceptions have led them into bad places. You can’t create nuclear power
overnight. Will take a decade. There is headline risk.

The issue is when people say that they are willing to face the pain of less energy. For a professor in London, it’s buying a Toyota Prius rather than an ICE vehicle. To a mine worker in Pennsylvania, they might not have any heat this winter when temps drop. Pain of virtue is disproportionately felt by the people who can least afford it. This elitist aspect of ESG needs to be talked about.

On ESG practitioners knowing better than others

Damodaran: This really p***** me off when I have discussions with ESG folks. They say, “We know,”
who is “We?” How do they know what people collectively want? Who appointed Sustainalytics to be the god in this universe? Name one “S” issue where you can find consensus? [This opens] the door to make everything political. I warned about this in 2019. ESG advocates complain of the politics. Like pyromaniacs complaining about the number fires.

Being good, beneficial company choice is personal, self-sacrifice

Mark: Alcohol/tobacco companies versus Coke and Pepsi. Type 2 diabetes and obesity, of which Coke/Pepsi are major contributors, cost our country more than $1Tln/year, well more than alcohol and tobacco. School vending machines are filled with junk food. Yet KO and PEP are the top 2 holdings at
Nuveen’s ESG fund.

Damodaran: Being good is person specific. The S&P can’t choose this for me. It’s like religion. There’s
personal sacrifice. Stop the lies. Being good is not easy and will cost. If ESG had been framed as, “You sacrifice. You can be good on a personal level of investment choice, but the cost is you will get lower returns,” then I’d have no problem with it. Being good will cost you and returns will be less.

Current State of ESG, how it got here

Damodaran: ESG was sold with a lie and it’s now driving the movement. They sold investors on ESG funds and higher returns. How the heck do you walk away from that now? And btw, ESG adds constraints, that lowers returns, you can’t say that anymore, because your entire business is built on the premise that ESG adds returns. False sales pitch, to investors, companies, AND people.

Mark: The CEOs are pushing back now. So, who leads the ESG push, where’s it going?

Damodaran: One of two groups are leading ESG now. They are either useful idiots who think they are making world better place or feckless knaves. There is no middle ground. On calls when I hear the ESG pitch, I think to myself which of those two is this person? There’s no third choice.

A lot of excess will get washed away in the next year or two as reality hits the economy and markets.
That’s what the market needs. It needs a cleansing. We are going to go through one of those. This will
present people with their own delusions. Do you still believe in this (ESG)?

Mark: It’s sort of like, “Everyone has an ESG plan until they get punched in the PnL face.” What’s next for
ESG, businesses?

Damodaran: ESG will get toxic enough. It will get replaced with another fuzzy word, maybe “Sustainability” or “Impact,” with “Sustainability” in the lead as its broader, more difficult to nail down. Chief Sustainability Officers don’t know what they are doing. Utter confusion, they cannot even explain it when I ask.

Mark: Investors and the general audience, how do they receive you, especially the ESG proponents?

Damodaran: I have no axe to grind. They accept my views. I care about business and what drives value. ESG is a bad idea from this perspective. If you want to argue it’s a good political game, then go play. But I don’t wish to do that. Just don’t impose this stuff on businesses. Weapons delivered to Ukraine are fine, but to Russia are not fine. It has to be nuanced.

I try and avoid the politics of it all. I care about businesses and investing grounds, that way I can reach the broadest audience. I care about businesses and what drives valuation, and in that regard ESG is a bad idea.

On How It Moves Going Forward

Mark: I am looking at things through as apolitical lens as I can. These exclusions, the Orphans, are vital; not political. I don’t want to get pigeon-holed and create worse political vibes than there already are. What’s the outlook?

Damodaran: The “E” will be deemphasized. Everything moves towards the “S” and becomes entirely
political. Measuring goodness on diversity, require them to break it down by race, sex/gender, etc. it will become a complete political discussion. The “S” has to be removed entirely. It doesn’t belong in businesses. “G” a complete misnomer. Nothing to do with corporate governance.

But we can’t make managers accountable to every single shareholder, stakeholder. Be honest about it. If you want to bring E, S, or G into the equation, someone must bear the costs. Get shareholders to approve the E, the S, the G while understanding all these things have costs, will lower returns.

Hershey’s spends millions on sourcing cocoa and sugar. Do shareholders vote on that? Do they know it
raises costs? How many Hershey’s consumers buy their products due to this costly sourcing? In the end,
“being good” as a company has nothing to do with increasing sales or lowering costs (it increases them.)
It costs everyone else money and decreases the value as a company, in the shareholder’s eyes. That’s a
failed fiduciary responsibility.

The ESG Elephant In The Room

Damodaran: BLK can never admit that being good costs money. The minute they do that, they have a fiduciary problem the size of an elephant. Managing other peoples’ money, if they say, “ESG costs us 50bps of performance, it’s game over, done!” They painted themselves into a corner. They need to KEEP telling people that being good will earn higher returns. No way for them, to back out of it.

Mark: Thanks so much for your time, Professor. Let’s do this again.

Damodaran: Sure thing Mark. Thank you.