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What it takes to be a Responsible Capitalist




In the 1987 movie Wall Street, Michael Douglas as Gordon Gekko gave a speech where he said, "Greed, for lack of a better word, is good." He went on to make the point that greed is a clean drive that "captures the essence of the evolutionary spirit". I remember watching this as a kid and thinking that this was exactly what I wanted to be. He spoke to my Darwinian inner predator.


Ayn Rand, famous for her colossal novel "Atlas Shrugged", maintained that capitalism is the only morally socio-political system because it frees people to act in their rational self-interest. She asserted that no politico-economic system in history has ever proved its value so eloquently or has benefited mankind so greatly.


As I grew older, I started to wonder how the continuous pursuit of individual profit maximization could be good for everyone. Does the money miraculously trickle down to the masses and make society a better place financially?  Then I stumbled across the works of a little known German philosopher Karl Marx who said that capitalism did not work towards the common good. Whereas Adam Smith, the author of "Wealth of Nations" and the father of capitalism, saw the maximizing of self-interest resulting in a state of equilibrium, Karl Marx saw something else. He saw exploitation or a situation where an individual is not receiving benefits to meet his or her needs.


Forget about the Rumble in the Jungle in Zaire between heavyweight champion George Foreman and Muhammad Ali.  How about Adam Smith versus Karl Marx live at the MGM Grand in Las Vegas?


One thing that we learned about the 2008 financial crisis is that greed is not necessarily good. It was the toxic mix of banker greed and highly leveraged and complex financial derivatives that lead to the demise of Lehman Brothers and the biggest financial meltdown in the history of humanity.


To understand this greed, you need to know how bankers are compensated. It does not promote moral behavior. When a banker steps into the office on January 1st, he knows that his world for the next twelve months is binary. He can either swing for the fences and take massive risks or he can play it safe.


If he swings at every ball that is thrown at him, he may hit some and he may miss some. He will either make a lot of money or lose a lot of money. If he makes a lot of money, it is Verve Cliquot Brut all around, a fat bonus, Italian sports cars and gambling weekends to Monte Carlo. If he loses big, he may get fired (but there are lots of other jobs around) but there are no negative bonuses. He will not be called on to chip in for what he lost.


He would be a fool not to seek out risk and gulp it down like a teenage kid with a beer pitcher on spring break. This is known as the privatization of profits and the socialization of losses. This very same risk-taking culture was endorsed after the financial crisis when governments bailed out reckless banks. 


The Emergency Economic Stabilization Act of 2008, often called the "bank bailout of 2008," was proposed by Treasury Secretary Henry Paulson, passed by the 110th United States Congress, and signed into law by President George W. Bush. The act became law as part of Public Law 110-343 on October 3, 2008, during the financial crisis of 2007–2008.


The law created the Troubled Asset Relief Program to purchase distressed assets from financial institutions. If an alien from out of space, assuming that he had a better than average grasp of the English language, had to read this he would be more than a little puzzled. Why in the world would you need to create a relief fund for the greediest and historically most profitable organizations on the face of the earth? A relief fund for Wall Street is as mindless as towing a monstrous iceberg from Antarctica to Alaska to help the Eskimos make a giant pitcher of crushed ice for their margaritas. This is not to be confused with the South African who wants to tow an iceberg from Antarctica to supply Cape Town with water – that is genius.


When the government bails out banks for bad behavior they are sending the wrong message. It is like rewarding a kid when they act well and supporting and comforting them when they behave badly. You are going to create a monster. Those are the kids rolling on the floor kicking and screaming in aisle 7 of your local Wal-Mart because mommy refuses to buy Junior a box of Cap'n Crunch Original. 


Capitalism is Broken


The gap between the rich and the poor is rising and it is causing havoc around the world. According to data from Bloomberg, the wealthiest 30 people in the world controlled a combined wealth of $1.6 trillion in 2019.  This is more or less the same size as Canada, the world's tenth-largest country. That is an obscene amount of money. 


Before the opening of the World Economic Forum in Davos in January 2019, Oxfam launched a report on income inequality.  In the 10 years since the financial crisis, the number of billionaires has nearly doubled. Between 2017 and 2018 a new billionaire was created every two days. The world's richest man, Jeff Bezos, the owner of Amazon, saw his fortune increase to $112bn. Just one percent of his fortune is equivalent to the whole health budget for Ethiopia, a country of 105 million people. In addition, these billionaires pay minimal tax.


The poorest 10 percent of Britons are paying a higher effective tax rate than the richest 10 percent (49 percent compared with 34 percent) once taxes on consumption such as VAT are taken into account. This is absolutely bonkers. This would all be easier to stomach if billionaires were salt of the earth people. Unfortunately, some are far from that. Case in point is Jeffrey Epstein, a low life, a perverted bottom feeder that sexually preyed on underage girls.  This miscreant reprobate is now weeping and gnashing his teeth for all eternity under the watchful eye of Adolf and his satanic crew of misfits.


So how do you measure wealth inequality? The Gini index or Gini coefficient is a statistical measure of distribution developed by the Italian statistician Corrado Gini in 1912. It is used as a gauge of economic inequality, measuring income distribution or, less commonly, wealth distribution among a population.


A society that scores 0.0 on the Gini scale has perfect equality in income distribution. Higher the number over 0 higher the inequality, and the score of 1.0 (or 100) indicates total inequality where only one person corners all the income. According to information from the World Bank published in 2018, South Africa is the most unequal country in the world. South Africa was also the country that presented the first opportunity for selective disinvestment in the 1970s.


According to the World Bank report, seven of the ten most unequal countries in the world are from Africa while the remaining three are from Latin America (Brazil, Colombia, and Panama). The ten most unequal countries are emerging markets. Ukraine, Iceland, and Slovenia are the most equal in terms of income distribution.


Those puzzled by the global rise of populism should put both hands on the ground, apply as much pressure to them as possible and extract their heads from the sand. Halfway through the Trump presidency, there were still democrats walking around bewildered and dazed wondering how a reality TV star could be president? Liberal Britons are no less confused with Brexit. This wave of populism is directly related to inequality.


Sir Angus Deaton, the Nobel prize-winning economist said: "There is this feeling that contemporary capitalism is not working for everybody".  He adds that "We've created this meritocratic aristocracy and people who didn't make it are pissed off."


Many feel the system is rigged. When the three wealthiest men in the U.S. own more than 160 million Americans, it should not come as a surprise that the U.S. has their first orange president. He came at the right time with the right message and delivered it to the right audience. Trump is a genius marketer.  His single biggest weapon is the fact that most people think he crawled out of a PT Barnum’s circus.


Gender Equality - Moving Slower than a Central African Airport Official


Kate Whiting, Senior Writer for the World Economic Forum published an article that made me fall off my chair. The article is entitled "7 surprising and outrageous stats about gender inequality". I was under the impression that we were making progress in the realm of gender equality. I am unhappy to say that we still have a very long way to go.


Firstly, women are 47% more likely to suffer severe injuries in car crashes because safety features are designed for men. Secondly, 33,000 girls become child brides every day in communities where girls are not valued as highly as boys and a married of quickly to transfer the economic burden onto another family.


Thirdly, women in rural parts of Africa spend 40 billion hours a year collecting water.  Fourthly, at the current rate of progress, it will take another 108 years to reach gender parity. Across the 106 countries covered since the first edition of the report, the biggest gaps to close are in the economic and political empowerment dimensions, which will take 202 and 107 years to close, respectively.


Fifthly, only 6 countries give women equal legal work rights as men. It found that only Belgium, Denmark, France, Latvia, Luxembourg, and Sweden scored full marks on eight indicators. These indicators ranged from receiving a pension to freedom of movement.


Sixthly (if such a word exists), 2 percent of AI (Artificial Intelligence) professionals are women. This could be due to lack of confidence. In 2012, just 14 percent of women starting university in OECD countries chose science-related subjects, compared with 39 percent of men. A 2015 PISA report found even high-achieving girls underachieved when they were asked to 'think like scientists'. Girls were less confident at solving science and math problems and reported higher levels of anxiety towards math.


Finally, for every female film character, there are 2.24 men. The Geena Davis Institute analyzed 120 theatrical releases between 2010 and 2013 in 10 countries. They found that of the 5,799 speaking or named characters, less than a third (30.9 percent) were female and more than a third (69.1 percent) were male.


The Roots of Ethical Investing


An extreme example of worker exploitation can be found in my home country, South Africa. The legalization of racism in South Africa in 1948 provided the world with one of the first opportunities for selective disinvestment along ethical lines.


In 1971, Leon Sullivan, an Afro-American Baptist minister, and human rights activist joined the board of General Motors. In 1977, he developed the Sullivan principles which were a code of conduct to promote corporate social responsibility. Sullivan lobbied GM and other large U.S. corporations to divest from South Africa while the system of apartheid was still in place. 


What does Ethical Investing Mean?


Ethics is that part of philosophy that deals with the good and bad, or right and wrong in human conduct.  This is where we get into a little conundrum because we need to ask if morality is absolute or relative. 


An example of absolute morality would be practiced by the Christians and embodied in the Ten Commandments. Relative morality, however, also has its fair share of supporters.


Marx argued that morality was a tool used to give power to the ruling class. Relativists do not believe that anyone person should dictate how others conduct their lives. Ethical investing means different things to different people. The objective of this book is to show how ethical investing has evolved and what factors are taken into account in the identification of "ethical" investments.


ESG – Environmental, Social and Governance


Ethical investing demands that companies, in addition to adding value to shareholders economically, also pay attention to issues such as the environment, social and governance (ESG).   Companies are given and ESG score. The higher the score, the more sustainable the business.


To understand this, we will look at the German automaker Volkswagen. In 2015, Volkswagen came under the scrutiny of the United States Environmental Protection Agency (EPA). The EPA discovered that the company intentionally programmed turbocharged direct injection diesel engines to only activate their emission controls during laboratory tests.


When the vehicles were out on the road transporting the kids to soccer matches, these vehicles were emitting 40 times more pollutants than in the tests.


This scandal became known as Dieselgate or Emissionsgate. After this scandal, VW made an effort to get their act into gear and are going to use this example to explain how companies are scored on ESG. The numbers are correct as in October 2019 according to information provided by Bloomberg.


Environmental


This segment looks at total greenhouse gas emissions per million dollars in revenue (VW: 37.1 – lower value is “better”), total energy use (megawatt hours) per million dollars of revenue (VW: 102.3 – lower value is “better”), total water use (cubic meters) per million of revenue (VW: 236 – lower value is “better”), total waste (tons) per million dollars of revenue (VW: 14 – lower value is better) and the percentage of water recycled (VW: not scored – higher value is “better”).


Social


This segment looks at ratio of women in the total workforce to women in management (VW: 0.65 – a higher value is “better”), women employees as a percentage of total workforce (VW: 16.5 – higher value is “better”), employee turnover percentage (VW: 0.6 – the lower value is “better”), employees unionized as a percentage (VW: not scored – higher value is “better”) and lost time incident rate (VW: not scored – lower score is “better”).


Governance


This segment looks at the percentage of independent directors (VW: 25 – the higher value is “better”), percentage of board members that are women (VW: 25 – the higher value is “better”), director average age (VW: 58 – lower value is “better”), director meeting attendance percentage (VW: 90 – higher value is “better”), and Board Size (VW: 20 – lower value is “better”).


Case Study


Ethical investing is noble but how has it performed in the past? Are investors prepared to sacrifice returns in favor of investing in responsible companies? Some consumers are prepared to pay a higher price for a garment or item if they know that the manufacture and delivery process of the good was measured to have minimal impact on the environment, that no child labor was used and that women played an important role in the process. Does this same activism flow over into the world of investing? How have responsible companies performed in comparision to "irresponsible" companies?

In October 2019, I ran a backtest in Bloomberg. I selected all the companies in the world that had an ESG score above 50 and compared their performance to the companies with scores below 50.


I discovered that my ESG stocks have underperformed "traditional" stocks between 2009 and 2019 during the market rally. But the market does not always go up. They move around and when they get spooked, stocks fall like a stone. Merrill Lynch found this out the hard way during the 2008 financial crisis. Their byline used to be "Be Bullish". The financial crisis taught them that this was strategy did not always work. When the market turns nasty, you face a different reality. You find yourself in a dusty coliseum armed only with a butter knife and a used toothpick against a phalanx of hungry lactose intolerant tigers. These tigers are looking for meat and you, standing sheepishly in your sensible orthopedic shoes, are looking very tasty.


When the Dow Jones Industrial Average declined 35 percent between February 20th and March 20th on account of the coronavirus scare, ESG stocks on average declined around 20 percent. The argument in favor of ESG stocks revolves around the debate of quality of returns. They may deliver less return, but they also expose the investor to less risk. In other words, they deliver better risk adjusted returns.