From London to New York, an iron curtain is rapidly descending on research departments across Wall Street in the form of the sustainable investment movement, which posits that environmental, social, and governance, or ESG, factors are the key to market outperformance over the long term. Analysts that don’t get on board with the ESG program — especially when it comes to climate action and the need to decarbonize — run the risk of being canceled.
Like the lawyers in Shakespeare’s Henry VI, Wall Street research analysts — whose fundamental sector and company analysis provides the underpinnings for security valuation and efficient primary and liquid secondary trading markets — stand in the way of the ESG mob now intent on creating a “sustainable global financial system.”
Consequently, one of the first things that ESG activists have focused on with their integration efforts over the past five years has been to co-opt research analysts on both the sell-side and the buy-side of the business and enlist them — mostly under duress — to serve as the Praetorian Guard for the ESG movement.
The United Nations’s Principles for Responsible Investment, or UNPRI, the leading sustainability advocate on Wall Street, requires all of its 3,749 investment manager members to incorporate ESG into their in-house research processes. All of these buy-side accounts, in turn, are also encouraged to withhold broker commissions and research poll votes from any sell-side firm for which analysts are not doing the same. Since annual Institutional Investor research rankings are one of the main drivers of sell-side analyst compensation, this tends to cut down on ESG dissent.
Investment banks and asset management firms are also responding to UNPRI pressure by hiring an army of sustainability specialists to chaperone and look over the shoulders of seasoned fundamental analysts in their daily interactions with their coverage companies. Apparently, senior management imposing ESG top-down on Wall Street analysts is not a conflict of interest that currently needs to be disclosed in sell-side research reports or investment fund marketing materials.
As one leading fixed income analyst confided, “Wall Street follows the money. The market (sell-side and buy-side) is running around hiring ESG specialists left and right and building up ESG practices. It’s hard for anyone to be too critical without putting oneself into direct conflict not just with business strategy, but also exposing oneself to attack on ideological fronts.”
Another sell-side researcher put a finer point on it: “Pushing back on ESG can be toxic to your livelihood. As soon as collaborating on ESG research became part of the analyst evaluation and annual compensation process, all hope of challenging it went out the window.”
Research analysts are now being forced to suspend disbelief and forgo the traditional financial approach that they have used for decades to analyze and value company securities. Rather than comparing leverage metrics, cash flow margins, and earnings momentum, analysts are now sizing up carbon footprints, checking on water and electricity usage, and making sure companies are paying their “fair share” of corporate taxes.
Company earnings calls and shareholder meetings are increasingly dominated by ESG-related questions and disclosure demands from analysts. Harassing and haranguing corporate management teams to set and hit sustainability targets for their businesses is what passes for research coverage these days in the brave new world of ESG.
As one senior buy-side analyst complained, “Instead of focusing on fundamentals as the economy is turning, I am spending my time on immaterial, non-financial ESG factors that have no bearing on valuation. Every research recommendation I make these days needs to be justified on ESG terms just to check the sustainability box with upper management.”
Wall Street research analysts are paid to have an opinion and market their views, yet no one currently working in the business has ever gone on record to question the sustainability orthodoxy publicly — mainly due to fear of retribution. The sounds of silence from the research rank and file are deafening, particularly from those analysts covering the oil and gas industry who will soon be out of a job if ESG investing is taken to its logical conclusion.
This is unfortunate because fundamental research analysts are the best equipped to challenge the sophistry of sustainability. A short list of due diligence questions would suffice to expose the fatal flaws of the ESG argument.
Sustainable investing has been around since the 1980s, so why is there such a dearth of empirical data showing that an ESG approach actually leads to better investor outcomes?
Corporate sustainability is another way of saying bankruptcy risk, so why can’t we just keep on using the same credit ratings that have been assigned by the major agencies for more than the past century, given that these are designed to predict default rates?
Why would running a company for the benefit of every constituency in society except for capital providers such as shareholders and creditors necessarily lead to improved pricing for financial assets such as stocks, bonds, and bank loans?
How is it not a breach of fiduciary duty to impose an ESG framework ex-post on an existing fund without a sustainable mandate?
Other than ESG enablers, clean energy sponsors, sustainable fund managers charging higher fees, and companies saving a few basis points by issuing virtuously labeled bonds, how many investors are consistently making money from sustainable investing?
And lastly, since climate change is the No. 1 ESG priority, why is it that the ubiquitous hockey stick chart used to rally support for the cause (i.e., carbon emissions versus temperature anomalies since 1880) cannot be included in any Wall Street research report since it violates Financial Industry Regulatory Authority, or FINRA, standards by being highly misleading due to its distorted scale and opaque data?
With the Federal Reserve now raising interest rates and pulling back on its quantitative support for the market, fundamentals should hopefully start to matter once again as the pricing of all risk assets starts to normalize going forward. Against this, though, U.S. and European regulators are now ramping up new sustainable disclosure and fund reporting requirements to mandate ESG compliance by most market participants.
ESG is now bringing down the curtain on independent Wall Street research, which is a tragedy for a great profession and everyone invested in the financial markets.
Paul Tice is a former Wall Street research analyst and an adjunct professor of finance at New York University’s Stern School of Business.
