Admission Impossible: Or, What Brilliant People Do When They Don’t Know Something
Commentary by Julie Fox Gorte, Senior Vice President, Sustainable Investing
Warren Buffett, aka the Oracle of Omaha, is a very smart man, and his investors are happily loyal. So when he says things, we all listen, and many of us assume he’s right. But I have yet to find anyone so smart that they’re incapable of being wrong, and in my opinion Warren Buffett is wrong about ESG.1 My evidence comes from a recent article in the Los Angeles Times,2 in which Mr. Buffett opined on a shareholder proposal that he divest PetroChina, a company accused of doing business with the government of the Sudan. Mr. Buffett is quoted as saying that “[i]t’s very difficult to judge the actions of companies that act on thousands of things every day.”
Quite. In fact, there is no better example of this than active portfolio management, or picking stocks that are expected to outperform in order to generate returns that beat themarket. Financial economists have demonstrated repeatedly that it is very difficult for active managers to consistently do better than the market, and this has “inspired the move over the past decade away from activemanagement…to passive management (trying to match the market.”3 Yet Mr. Buffett has proved his acumen, year after year, in active portfolio management, reportedly starting with $10,000 in the 1950s and winding up with billions today. Clearly, Mr. Buffett is undaunted by the difficulty of his chosen profession. He seems flummoxed by mine, however, or at least by the E and the S in ESG.
Mr. Buffett has high standards on governance, and his views have probably helped shape more than one company’s governance structures. He is also militant that executive compensation be simple and fair, and he puts the blame squarely on board compensation committees when it isn’t. For example, he urges shareholders to join him in demanding fair and independent reviews of executive compensation in his 2006 letter to shareholders:
“Irrational and excessive comp practices will not be materially changed by disclosure or by ‘independent’ comp committee members. Indeed, I think it’s likely that the reason I was rejected for service on so many comp committees was that I was regarded as too independent. Compensation reform will only occur if the largest institutional shareholders—it would only take a few – demand a fresh look at the whole system. The consultants’ present drill of deftly selecting ‘peer’ companies to compare with their clients will only perpetuate present excesses.”
Yet he rejects the idea that shareholder pressure can be effective on social and environmental matters, at least with respect to divestment of companies operating in the Sudan, saying, according to the LA Times, that moral suasion would be “fruitless.”
This is a familiar theme. The managers of the Bill and Melinda Gates foundation share this view; Patricia Stonesifer, the Gates Foundation’s CEO, wrote to the LA Times that changes in investment practices would have little or no influence on corporate behavior. At some level, Stonesifer and Buffett are right: individual shareholders usually don’t have much influence, any more than individual voters or consumers do. On the other hand, collective action is enormously effective. How many companies have adopted majority voting because their shareholders voted resoundingly in favor of it, or as part of the domino effect of some other company’s proxy vote? According to an ISS blog of January 17, “more than 25” firms either adopted majority voting or announced their intention to adopt it in the six weeks prior to the posting, and in the first half of 2006, shareholder support for majority voting proposals averaged nearly 48%; 36 proposals actually received more than 50% support.4
It is curious, then, that Mr. Buffett seems to regard analysis of ESG—or at least the “E” and the “S”—with such skepticism, and sees shareholder pressure as ineffective. Or perhaps it isn’t quite so curious.
Neil DeGrasse Tyson, director of the Hayden Planetarium at the American Museum of Natural History and another very smart man, makes a powerful case about what deep thinkers do when faced with things they do not understand. Writing in 2005, Tyson notes,
“…a careful reading of older texts, particularly those concerned with the universe itself, shows that [scientists] invoke divinity only when they reach the boundaries of their understanding. They appeal to a higher power only when staring into the ocean of their own ignorance. They call on God only from the lonely and precarious edge of incomprehension. Where they feel certain about their explanations, however, God gets hardly a mention.”
We often observe a similar reaction when very smart and very powerful investors are confronted with the limits of their own knowledge: a tendency to dismiss. Those who do not understand how to analyze ESG factors tend to dismiss them as either unknowable or immaterial. They are neither. There are countless examples of stock prices reacting to environmental and social “surprises” (usually unpleasant ones) and an increasingly voluminous and quite respectable literature, often from blue-chip sell-side houses, analyzing the materiality of ESG factors and distinguishing leaders from laggards. In the world of sustainable investing, we analyze ESG factors routinely, and have developed ways to judge performance that resembles the methods active portfolio managers use to distinguish companies that should outperform from the hoi polloi. In fact, we believe that strong ESG performance is a characteristic of better-managed, more innovative companies that are better positioned than their less enlightened peers to deliver sustainable, long-term shareholder value.
So, much as we respect and admire him, we at Pax World choose to disagree with Mr. Buffett’s pronouncements on the value of corporate social responsibility, or the efficacy of shareholder suasion. And before anyone else concludes that investors need sustainability analysis like a fish needs a bicycle, I would simply urge that the answer be illuminated by knowledge before being dismissed as “fruitless.”
1I am using “ESG” as shorthand for socially responsible or sustainable investment strategies – integrating environmental, social and governance (ESG) factors into financial analysis and decision making.
2Charles Piller, “Buffett Rebuffs Efforts to Rate Corporate Conduct,” Los Angeles Times, May 7, 2007.
3Richard C. Grinold and Ronald N. Kahn, Active Portfolio Management: A Quantitative Approach for Producing Superior Returns and Controlling Risk, (New York: McGraw Hill, 2000), p. 1.
4Rosanna Landis Weaver, “2007 Preview: Board Elections,” posted at: http://blog.issproxy.com/majority_voting/, January 17, 2007.