Social reformers, religious zealots, the politically correct, the politically active, tree huggers, the elitists and a host of other individuals with non-libertarian attitudes have difficulty accepting cold, hard, facts. Rather than acknowledging society as it is and trying to explain why it is that way, these people want to change it. Positivism, on the other hand, (like Buddhism) is all about acceptance. Much can be learned from understanding the way things are rather than simply objecting to facts of life and trying to impose something different.
Passive investing is the ultimate expression of acceptance, the Buddhism of Finance, joining the capital flow rather than fighting it. Passive investing simply buys the market with all its glorious technological superstars like Tesla and all its dirty polluters, its gun manufacturers and even fraudulent companies that happen to make it into the index. Passive investing happens to outperform the multitudes of active investors who impose their value judgments on every index component – from this standpoint, passive investment is optimal. The passive-positive approach is best.
So it is with great surprise that Larry Fink, the head of Blackrock, the largest passive investment house in the world, has decided that passive investment needs to change. His letter to Corporate Heads this year has placed purely passive investing in the co-pilot’s seat and substituting a suite of ESG-tilted passive funds as the default option for the USD7Trillion in their investments. ESG stands for Environmental, Social and Governance and from now on Blackrock will favour companies with high ESG rankings over low ones. This is magnanimous, bold, benevolent even…but crucially departs from the core philosophy of being passive which is being positive and accepting. We might not like the polluters, the guns and the fraudsters but they are there for a reason.
In simple terms, diverting capital away from low ESGs to high ESGs will cause the relative price to fall today – but consequently their relative future returns need to be higher to attract future capital. Blackrock’s ESG-tilted funds are therefore destined to underperform their pure passive funds…imposing lower returns on their investors for ESG reasons would seem a breach of fiduciary duty. This is particularly the case where there is no standard to judge the beneficial external impacts of ESG initiatives.
The irony is that Blackrock is adopting a novel form of active management, precisely the investment approach that they have debunked and from which they have won market share. Pure passive investors must be relishing the chance to take them on.
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