Forget about 'ESG,' evangelists misappropriating the underlying concept to convert companies to 'do good,' critics relying on fallacious arguments to defeat it, and the deeply partisan politics around it.
Instead, imagine an asset manager considering investing in a specific sector from a purely rational perspective relying on hardcore corporate finance principles. Their honorable objective is to generate excess returns over a short, 12-month period.
The asset manager identified two publicly listed industry participants, Company A and Company B. Both are pure-play operators. They are equally sized with the same market share, revenues, and geographic mix. They also enjoy identical profitability and return on capital profiles. They have historically followed similar investment patterns in tangible and intangible assets, including R&D. Their financial targets (growth, operating margin, return on capital) for 2028 are the same in all material respects and are equally credible when considering management quality. Finally, they are similarly capitalized.
A and B trade at the same valuation multiple and have the same equity value. The asset manager marvels at the rare occurrence of perfect market efficiency: prices appropriately reflect all available information. Eugene Fama would be ecstatic. The asset manager can pick either A or B and accomplish their mission.
Within a short period, the same asset manager and the broader investor community gain access to additional, non-financial corporate information made readily available by financial market data providers.
* in tons/$ million revenues ** in MWh/$ million revenues
The implications for the asset manager's investment decision process start with a broader market assessment: will financial market participants consider the additional information in their evaluation of A and B? If they do, which KPIs will be regarded as most material to the company's future cash flow generation potential? Will the newly uncovered arbitrage opportunity favor Company A or B?
Given this new background, which company should the asset manager buy or short, considering the evolution of various world scenarios during the contemplated holding period? Naturally, the same questions would apply to a private equity firm seeking to make an investment with a 5-year holding period. Or to a corporate making an acquisition 'forever.'
All investors – asset managers, institutional investors, private equity firms, and corporates – may forget about 'ESG.' But prices will not forget to reflect all available information.