Ethical investors tend to think about the environmental, social and governance (ESG) stocks to buy and avoid, but too few go a step further and shorting those that score poorly on sustainable metrics.
This is the view of Argonaut’s Barry Norris, who said betting against these companies could play an important role for improving the governance of the overall stock market by calling out poor corporate practice.
This idea is not being fully “utilised or monetised” by ethical investors, he said, although his VT Argonaut Absolute Return does not have an ESG mandate itself.
Shorting is an strategy that invests in the potential decline of a stock or other security price by selling shares with a view to buying them back at a later date. It is an advanced idea that is not recommended to inexperienced investors, however.
However, Norris’ view has been denounced by ESG fund managers such as Simon Holmes, manager of the BMO GAM Sustainable Universal Multi Asset Portfolio range, who argued that knee-jerk investment reactions to companies will not create better businesses.
Below, both put their views forward on why investors should or should not think about shorting when investing in ESG stocks.
The ESG case for short selling
Argonaut’s Barry Norris: “Good corporate governance is often confused with box-ticking virtue-signalling”
“In recent times, big institutional shareholders have leveraged their outsized positions to pressurise management into running public companies according to ‘woke’ political agendas. Good corporate governance is often confused with box-ticking virtue-signalling,” Norris said.
The manager said the governance demands of the average investor are simple – they want to make sure that management is running a company in the interests of all shareholders equally.
“They want management to run meritorious organisations that comply with the laws of the countries in which they operate, but above all they want CEOs to act as good stewards of their capital: ensure that financial accounts and statements are accurate and not to favour some investors over others, steal from shareholders through siphoning off assets to friends and family or use the company for personal self-aggrandisement,” he explained.
“The stock market will always have its fair share of shysters, fraudsters and incompetents. ESG funds make great claims about how they work with company management to improve governance, but I cannot recall a single instance whereby they have uncovered a fraud? In fact, most of the stock markets’ recent blow-ups have all gone bust whilst still holding the highest ESG ratings. Perhaps self-publicising puritanism is a just smoke screen for more nefarious activities?”
Norris added that short sellers, and Argonaut in particular, have a proven track record of “unmasking fraudulent management”.
He said: “Argonaut has punched above its weight in terms of publicising smelly activity at South African conglomerate Steinhoff, FTSE 100 outfit NMC Healthcare and, of course, DAX 30 member Wirecard before they went bust – risking financial and reputational damage - rather than less bravely, after the event, like many large institutions that apparently saw the problems but kept quiet.
“Every other market participant is incentivised solely by rising share prices: only short-sellers can properly play the role of market vigilante in rooting out the worst cases of poor corporate governance.”
Engagement, not divestment, brings about change
BMO’s Simon Holmes: “If we simply short sell the company, we lose the opportunity to offer comprehensive, holistic support”
But not all managers agree that aggressive divestment is the way to bring about a positive change in corporate governance.
Simon Holmes, director and manager of the BMO GAM Sustainable Universal Multi Asset Portfolio range, argues that active engagement with companies is a more effective route to establishing better governance foundations within a business and short selling simply misses out on the opportunity to do this.
Holmes pointed of that BMO GAM in particular has a long history with this type of engagement having been actively engaging for over 21 years on behalf of internal and external clients. He said this gives the firm “significant influence and voting power”.
He said: “We look to be long-term investors in good companies and believe that an ongoing dialogue is the key to achieving sustainability goals on a both a company and societal level. In our experience, management is typically very open to engagement when it is done thoughtfully.
“Engagement can offer further expertise, different viewpoints and a way of increasing shareholder returns. In addition, positive engagements can lead to reduced business risk, better worker satisfaction and an improved environmental footprint. If we simply short sell the company, we lose the opportunity to offer comprehensive, holistic support.”
There are many benefits to being a direct investor, according to Holmes: “Access to company management is easier and is focused on driving positive change, often informed by sharing best practice through our work with other companies facing similar issues.
“This likely leads to a genuine, long-term commitment to improvement, rather than a hastily conceived and reactive response, which ultimately results in broad, lasting benefits for both the company and investors. Additionally, academic and practitioner research has found a strong link between financial performance and good management of ESG risks and opportunities, leading to better investment returns.
“When engaging with companies, we believe that the best results are achieved by outlining our expectations in advance – both generally (we have published our Environmental and Social Expectations and Corporate Governance Guidelines) and specifically with the company in question, whilst closely monitoring progress.”
But divestment is not totally off the table for the BMO GAM strategy, Holmes explained. Rather, it is simply a last ditch effort.
“However, if a company does not respond well to engagement, we retain the option of divesting as a last resort. For example, we have engaged with Smurfit Kappa over several years and seen significant improvements in the companies sustainability profile.
“This year, the company continued to improve the level of gender diversity on the board by appointing a fourth female non-executive director. This brings the percentage of female directors on the board up to 33%, meeting our minimum expectations for gender diversity at a company of this size.”