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According to Deloitte, ESG’s global assets under professional management could reach $80 trillion by 2024. But this growth in popularity combined with the global energy crisis has made the sector face increasing polarization. Critics worry that the capital earmarked for ESG investments will bolster one value system at the expense of others.
Lauren Taylor Wolfe co-founded Impactive Capital, a dynamic investment management firm focused on investing in ESG for the long term. I sat down with CNBC’s Delising Alpha newsletter to share why she believes banning investment in ESG can be so risky and how understanding environmental, social and governance risks is ultimately a good thing for businesses.
(Modified below for length and clarity. See above for the full video.)
Leslie Baker: Are you surprised that ESG has become one of the most controversial areas of finance in recent months?
Lauren Taylor Wolfe: no IAM not like that. Listen, ESG without returns is simply not sustainable. Hundreds of billions of dollars have been allocated in the United States alone to ESG ETFs and actively managed mutual funds. Globally, there have been a trillion[s] assigned. And like all things trendy, the pendulum sometimes swings a lot in one direction, and so, now there’s a lot of scrutiny on a lot of ESG products. But again, not every ESG product is created equal. As I mentioned before, these products simply won’t work without a return. Now at Impactive, we’re taking a different approach. And we’ve proven that you don’t have to sacrifice revenue to achieve good, solid ESG optimization. We think about two things: One, can you address the business problem with an ESG solution? And second, can this solution bring profitability and returns? We’ve seen a lot of pullback coming from some politicians and I think that’s simply too risky. Understanding environmental and social risks is simply a good fundamental analysis and is simply a good investment. So for countries, for example, to ban this type of investment, I think it’s simply too risky. It’s bad for retirees, and bad for voters, simply because it’s a good way to analyze business over the long term.
beak: I think the crux of the problem is the idea of ESG and profitability being mutually exclusive. Do you think there can be improvements in the environment, society and governance (ESG) that prompt margin expansion immediately? A lot of people say, “Well, in the long run, this is going to be a lot better for the company.” If you are a long-term producer of fossil fuels, the transition to green energy will be better for your survival. But if you’re a pensioner or an investor who needs a more short-term time horizon in terms of realizing your brands year on year, you need a more rapid turnaround there. Is it a matter of duration in terms of being able to drive that profitability?
Taylor Wolfe: We focus on two areas, the ESG effect and the capital allocation effect. The capital allocation effect is about, “Oh, you gotta sell the chip, do this enhanced summary, you have to make this acquisition.” This could have an immediate impact on returnees. ESG change is, for the most part, cumulative in nature and, in fact, takes longer to generate returns. But pensioners, as an example, have – this capital is almost forever. And so, you know, the market itself, I think, has been plagued by short-termism. We have a very large number of directors, CEOs and boards of directors who are focused on achieving their quarterly or annual numbers and we believe there is a real opportunity to focus on long-term returns and the long-term IRR. In fact, at Impactive, we guarantee a three- to five-year IRR because that’s where the real returns are possible. So, you should be able to look back a year ago…we have a car company, a car dealer, whose most valuable sectors are parts and services. It drives two-thirds of the company’s EBITDA, and across the industry there has been a labor shortage. And so, we told them, you’re completely ignoring one group of candidates, and that’s the women. You’re not attracting retaining women to become mechanics, but they dominate an industry where customers spend more than $200 billion annually on auto servicing and auto retail. Sure enough, they added the mechanics. Over the past two years, they have doubled the size of female mechanics. And we convinced them, oh my goodness, if you invest in benefits, like maternity leave or a flexible workweek, once you add females to mechanical strength, you can raise your usage from 50 percent to 55 percent while your competitors are stuck at 50 [percent]. And it will drive—because that’s the most profitable business that has the highest multiplier—that might pay 20 percent of your organization’s total value. And so I use this example to show you, it’s going to take time to go from one or two percent, where women are sitting as a percentage of the mechanics in the workforce, from one or two percent, to where I think 10 percent can go. This can have a significant impact on the overall value of the enterprise. It doesn’t happen overnight, but it can have a significant long-term impact on the overall revenue of this business.
beak: This raises a really good point – this idea that probably requires more creativity and some kind of new way of thinking, as opposed to what has been done historically. What do you think about the upfront cost of investing in something like this, investing in this transition, and how investors should think about just laying out the capital in order to make this transition possibly work up front, and the expectations for how that ultimately entails?
Taylor Wolfe: It will depend, right? If you’re encouraging a company to invest in a giant, new wind turbine facility, for wind and solar capabilities, or even for new segments, that would be a massive upfront spend. But it will pay off for several decades as we see a secular tailwind coming from government spending on renewable energy or consumer preferences and spending on renewable energy. For something like Asbury, where they are investing in paid maternity leave, they are adding women’s restrooms to their parts and services facilities – I think about 70% of parts and service facilities have women’s restrooms. These are smaller dollars, right? So, I think that spending will be cumulative almost immediately, because when they hire more mechanics, they generate higher dollar earnings than business revenue. But to answer your question directly, it really depends. The biggest outlays where you invest in renewable energy, very capital-intensive environmental products, which obviously have huge capital outlays and are much bigger than some of these asset-light initiatives, like hiring more mechanics, training them, adding them to your workforce so you can From accelerating your most profitable segment of growth at a single average rate to a double digit – that has a near-instant return.
beak: Yes, something as small as adding women’s bathrooms. It’s something you don’t think about, but it obviously makes a huge difference. I also want to ask you sort of how this all fits into the overall background, because historically, some people and some critics have said, “Oh, well, ESG. This is a bull market phenomenon. And it’s really nice to have, it’s something you can take advantage of when the economy In good shape, and when the markets are in good shape.” And that’s partly why we’ve seen such a large influx of capital into this area that has since inverted itself, at least in a lot of the traditional ESG-traded companies. But now we’re facing inflation, we’re facing rising interest rates, and the prospect of a possible recession, are you worried that ESG is going to take more of a back seat on the board, given some of these macro challenges?
Taylor Wolfe: I don’t think they will. I don’t think we’re going back to the days when the pursuit of profits was entirely at the expense of the environment, and our society is where we’re headed. And I think ESG’s smart initiatives are simply good business. It makes companies more competitive, more profitable and valuable in the long run. And we’ve looked at this, well, we’ve looked at — if you look at millennials and Generation Z, they care about how they spend their most important assets, their dollars and their time, and they do it more in a way that aligns with their value system. So what does this mean? These are the same people as your employees, customers, and shareholders. And as a company and board of directors think about this to the extent that you can attract and retain the most consistent customers, the most consistent employees, and the most consistent shareholders, you lower your customer acquisition costs, you lower your human capital costs, and you lower your total cost of capital. This makes your business more competitive, which makes it more profitable, which makes it more valuable in the long run. And certainly, in this kind of environment where we have a background of rising inflation, you know, rates are going up, and we might be in a recession or a recession that might be really, you know, only two quarters away, I think companies are thinking about how to keep up with prices, You know, how they can promote the moat around their business. A more sustainable solution will lead to price inflexibility, which will protect their business and profitability.
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