Thoroughly Stupid
By Brad Thomason, CPA
Oscar Wilde’s character Lord Henry Wotten had this to say in The Picture of Dorian Gray:
“Whenever a man does a thoroughly stupid thing, it is always from the noblest motives.”
In October the Department of Labor issued new guidance for pension fund managers, addressing the matter of investment selections made on the basis on nonfinancial factors. Specifically, the nonfinancial matters in focus are those which deal with an investee’s involvement in business activities which could have negative impacts on the environment and/or climate.
Some commentators have made a big deal out this development, speculating that it is the first move in a chess game designed to open managers up to charges that they breached their fiduciary responsibilities if they fail to consider such factors in investment selections. It is seen as a heavy-handed move to make investment managers act in ways which support the broader policies of the current administration.
Frankly, that wasn’t really my take away when reading through the explanation that DOL issued along with the new guidance. Seems to me that they are basically clarifying that they think it’s OK to use such considerations, and that they can even be primary consideration, if the pension manager believes that those factors are very important. It appears more a case of providing cover for those managers who want to do it, than a requirement that those who don’t want to have to anyway. The notice reiterates older language that in general, investing to support a cause is only OK if the support of the cause doesn’t come at the expense of investment returns. The focus, on the surface, still seems to be on making sure that pensioners get good returns, and that managers have the latitude to pursue them. But that said, I certainly can’t say that there isn’t a secret agenda buried beneath; nor that those who have asserted as much are wrong.
What I can tell you though is this: sometimes you have to decide which win you want, because you may not be in a position to get multiple benefits at the same time. If that’s the case you better know which one is the most important to pursue. If the activity under consideration is investing, then proper, risk-adjusted returns need to be the first, second and third concerns. Not crusades.
I grew up around boats, and my father has always maintained that there is no such thing as a perfect boat, because a boat is always an exercise in compromises. If you want something that can handle big seas while underway, it’s going to rock like crazy when you stop. And if it’s stable when stopped, then you can expect to get beat to death if you have to move quickly over choppy waters. Boats that are well rigged for fishing don’t make very good platforms for scuba diving, nor vice versa. And neither is particularly good if you want to stylishly transport well-dressed persons to a dinner party somewhere across the water.
Investing though can be a good bit more linear. The capital involved should do the financial job you need it to do. Full stop. Trying to make it have a higher purpose is often a means to guaranteeing that its core purpose is going to go undone. Where compromising in boats may be unavoidable, it is far more voluntary when it comes to investing.
The idea of values (as opposed to value) investing is not new. Whether you are against tobacco, deforestation, oppressive regimes or green house gas emissions, there’s no shortage of suppliers out there who will tie your investment returns to those beliefs. The DOL guidance from this fall updates a conversation which it started on this matter back in 1994. So this thesis has been out there for awhile. But plenty of bad ideas have long lives.
Proponents of these strategies usually highlight performance numbers from funds or managers that have had market-beating returns. Which on the surface seems like pretty compelling evidence that there’s something to it. But stop and consider that if you constructed 100 different investment portfolios via completely random stock selection, you would expect about half of them to beat the other half. Finding some that did well wouldn’t be hard; in fact it would be a near-certainty.
Values investing very much could be just another coin toss, writ large, with no way to really demonstrate that the values-based selection was the driver of the extra returns, or that it was simply chance. No sane person would claim that the occurrence of heads in a series of throws was a result of heads being the superior side of the coin. Crowing about selected returns in the values investing space may stand on no firmer ground.
Should we care about causes? Sure. Should we take action to support them? I think so. But the kinds of dividends we need from our investments are the monetary sort, not the feel-good sort. Despite a glut of available propaganda, there’s no proof that investment selection actually helps or hurts any cause one way or the other.
There is ample evidence, however, that investors often don’t achieve the returns they need from their portfolios. This underperformance can come from a lot of places. Voluntarily taking on another potential source of failure, by selecting assets based on criteria that have nothing to do with financial performance, seems like the kind of thing which could cause a person to wake up some morning and conclude that they had been thoroughly stupid. Even if the motives are noble, that’s probably not something you really want to do.