THE LONG VIEW

Evan Simonoff

The environmental , social and governance movement has changed investing , but not everybody agrees on how .

NYONE TRYING TO UNDERSTAND HOW ESG INVESTING got to where it is today might be surprised to find that its origins can be traced to some unexpected places .

In 1970 , economist Milton Friedman wrote an article in the New York Times arguing that the primary overarching responsibility of a corporation was to produce profits for its shareholders . In his book Free To Choose , the future Nobel laureate maintained that the singular purpose of pursuing profits was justifiable as long as the company engaged “ in open and free competition without deception or fraud .”

Friedman dismissed executives who reasoned their business should have a “ social conscience ” and take “ seriously its responsibilities for providing employment , eliminating discrimination , avoiding pollution and whatever else may be the catchwords of the contemporary crop of reformers . In fact they are — or would be if they or anyone else took them seriously — preaching pure and unadulterated socialism .”

This caustic critique of corporate responsibility nearly coincided with the advent of Earth Day on April 22 , 1970 . But experts say the “ G ” ( governance ) in ESG established itself before the “ E ” ( environmental ) component .

After riding a post-World War II economic boom and a 17-year bull market ending in 1966 , corporate America grew fat , happy and calcified . Managements were seen as looking after their own interests , not those of shareholders .

Investors gradually became frustrated during the 15-year bear market from 1966 to 1982 . As the U . S . economy and equity market stagnated ,

Previous generations of directors often sided with entrenched management teams , but as the decade unfolded , the goal of maximizing value for shareholders ultimately reigned supreme .

Friedman ’ s analysis developed a following . An entire ecosystem of activist investors , arbitrageurs and corporate raiders appeared on the scene eager to profit off the mismanagement of undervalued public companies .

Once derided as rubber stamps displaying feckless support of management , corporate boards started to embrace a stronger sense of fiduciary responsibility beginning in the 1980s . Previous generations of directors often sided with entrenched management teams , but as the decade unfolded , the goal of maximizing value for shareholders ultimately reigned supreme .

With the concept of more aggressive capitalism gaining currency , intensified scrutiny of management led to improved oversight and corporate governance . Institutional investors who had once voted with their feet and dumped shares of badly run businesses began to demand more accountability . By the late 1980s , underperforming companies were being sold in hostile takeovers , and CEOs were getting ousted with regularity .

Today , many veteran asset managers would argue they ’ ve been using governance criteria as a key investment requirement long before “ ESG ” was a household word , according to Dana D ’ Auria , co-chief investment officer at Envestnet . Historical studies have consistently found that companies with stronger balance sheets and higher lev-

26 | FINANCIAL ADVISOR MAGAZINE | MAY 2022 WWW . FA-MAG . COM