Talk Your Book: The Opposite of ESG

Episode Summary

Executive Summary: The episode contrasts traditional ESG investing with an anti-ESG “orphan” strategy. The hosts discuss fossil fuels, capital allocation, and how ESG can distort markets, then interview Mark Newman of Constrained Capital, whose ETF targets sectors excluded by ESG—energy, nuclear, weapons, alcohol, tobacco, and gambling—arguing these assets are undervalued, underowned, and potentially higher-return diversifiers.

Main Topics: ESG as a capital-allocation force (Priority: 5/5): The hosts frame ESG as a major investing trend that accelerated in 2020-2021, influencing capital flows through model portfolios and large asset managers. The case for ESG “orphans” (Priority: 5/5): Mark Newman argues that sectors excluded by ESG have been starved of capital, creating mispricings and future return opportunities. Fossil fuels, energy security, and scarcity (Priority: 5/5): The conversation emphasizes that restricting fossil fuel and nuclear investment can reduce supply, raise prices, and create energy insecurity. The ambiguity of defining “good” companies (Priority: 4/5): The speakers debate the difficulty of drawing moral lines in investing, using examples like Facebook, Coke, Pepsi, and gun manufacturers. Critique of ESG’s returns and costs (Priority: 5/5): Newman cites academic critiques that ESG may raise costs and lower returns while imposing values without clear shareholder consent. ETF construction, liquidity, and diversification (Priority: 4/5): Newman explains the ETF’s market-cap-weighted basket, liquidity mechanics, and role as a diversification tool for investors overexposed to ESG-style portfolios.

Key Arguments: ESG can create capital misallocation by pushing money away from certain industries and into favored ones regardless of valuation. Underowned sectors often become more attractive because lower prices and forced lean operations can improve future returns. Fossil fuels and nuclear power remain essential to modern life; cutting them off too quickly creates real-world shortages and higher prices. Energy demand is not going away, especially in developing countries, so constrained supply may support higher long-term profitability for energy firms. ESG screens are inconsistent: many funds exclude tobacco/alcohol but still own companies like Coke, Pepsi, Apple, Amazon, and Microsoft. Defining what is “good” is subjective, so investors who want to express values may be better off separating investing from charity or activism. The ETF is pitched as a contrarian, value-tilted, low-correlation diversifier rather than a moral statement. Liquidity concerns are addressed by the scale of the underlying index and the fact that the holdings themselves are highly tradable.

Data Points: Useful energy availability: nearly 700x more - Average inhabitant today vs. ancestors at the beginning of the 19th century, cited from Vaclav Smil's book. Energy sector weight in S&P 500 (2009): 13.5% - Newman cites this as a prior peak before energy became heavily underowned. Energy sector weight in S&P 500 (end of 2021/beginning of 2022): less than 3% - Used to show how far energy exposure fell as ESG and growth stocks dominated. Energy sector weight in S&P 500 (current in discussion): about 5.5% to 6% - Newman says the sector recovered somewhat but still has room to run. Energy and food insecurity link: Germany shut down nuclear plants - Presented as an example of policy-driven energy constraints contributing to dependence on fossil fuels and geopolitical vulnerability. Coke/Pepsi societal cost estimate: $1 trillion a year - Newman attributes this to type 2 diabetes, obesity, and plastic bottles. Alcohol and tobacco societal cost estimate: $600 billion to $700 billion a year - Used to argue that ESG exclusions can be inconsistent relative to consumer-goods holdings like Coke and Pepsi. Weight cap per sector in the ETF index: 25% maximum - Index rule limiting concentration in any one sector. Weapons sector weight: 21% - Approximate weight in the ETF index at the time described. Alcohol weight: 12.5% - Approximate index weight. Tobacco weight: 12.5% - Approximate index weight. Gambling weight: 4% - Approximate index weight. Index size: $3 trillion - Newman describes the underlying ESG Orphans Index as very large relative to the ETF's AUM. Index constituents: 50 names - The underlying index includes 50 stocks. ETF launch timing: mid-May - Newman says the ETF launched in mid-May and had gained a little more than 6% since launch. ETF performance since launch: a little more than 6% - Return cited by Newman since mid-May launch. Index year-to-date performance: about 20% - Performance cited for the index itself year-to-date. Big Tech concentration in ESG funds: same top five as S&P/Nasdaq - Amazon, Apple, Microsoft, Google, Tesla are said to dominate ESG funds as well. Apple weight in S&P 500: 7% - Used to illustrate crowding in popular ESG-friendly portfolios.

Pivotal Quotes: "The ESG orphans are the exclusions from the ESG bubble of the past decade." — Mark Newman: Defines the core idea behind the ETF and the fund's investment philosophy. "We have massive problems in the world now, a lot of it attributable to ESG." — Mark Newman: Newman’s strongest critique of ESG's market and societal effects. "There's either feckless knaves or useless idiots pushing it now." — Mark Newman quoting/attributing to Damodaran: A sharply worded criticism of ESG advocacy used to underscore skepticism about the movement.

Implications: Listeners are left with a contrarian view: ESG can distort prices and create opportunities in excluded sectors. The episode suggests investors may want to separate values from portfolio construction and treat energy, tobacco, weapons, and similar sectors as potential diversifiers rather than moral proxies.