Keep other people’s politics away from your money. Your Survival Guy favors the selection and ownership of individual stocks to avoid the ESG crowd. In The Wall Street Journal, Matt Cole and Jeff Sherman discuss what they call “the charities hiding in your 401(k), writing:
Environmental, social and governance investing is like the wrinkle in the rug; stomp it down and you shift the problem somewhere else. As investors and lawmakers push against ESG’s presence in portfolios, it is infiltrating index funds wearing a new disguise: the public-benefit corporation, or PBC.
Unlike a standard corporation, obligated only to its owners, a PBC has a charter that requires it to pursue both shareholder profit and a specific social good. Shoemaker Allbirds says its purpose is “environmental conservation.” Lemonade Inc. says its insurance products will enable charitable giving “for the benefit of communities and their common causes.”
Socially conscious investors are free to use their money however they wish. The problem is that they have made their goals everyone’s. PBCs are beginning to sneak into indexes and the funds that track them. Twelve are already part of the Russell 2000 Index. One of those—AppHarvest, a food company seeking sustainability—declared bankruptcy in July. Allbirds stock has plummeted 96% since its initial public offering; Lemonade is down 83% since its IPO. These results are typical for PBCs, and worse than regular companies that went public at the same time.
Since 2017, when the first PBC went public, at least 18 companies, mostly S&P 500 constituents, have faced shareholder proposals from left-wing activists asking them to become PBCs, following in the footsteps of Veeva Systems and United Therapeutics, members of the Russell 1000 Index that became PBCs.
PBCs’ underperformance is no surprise. The PBC structure allows corporations to burn cash and otherwise destroy value by claiming to balance shareholders’ interests with those of other stakeholders.
Worse, activists can force PBCs to waste money. Delaware General Corporation Law on PBCs holds that shareholders with at least 2% of shares outstanding or $2 million of equity can file a lawsuit claiming that a company breached its fiduciary responsibility to any of the company’s stakeholders. That means ideologically driven shareholders such as blue-state public pensions can sue to force a company to sacrifice individual shareholders for some nebulous public good.
PBC share prices also have faltered because it is impossible to assign a fair value to them. The intrinsic value of a company is defined as the present value of all its future cash flows. When you buy stock in a PBC, how can you distinguish between how much of that future cash flow is yours and how much belongs to various stakeholders? What percentage of Allbirds’s future earnings is “owned” by the environment? What percentage of Lemonade’s is supposed to help undefined communities and their unspecified causes?
Because PBCs are impossible to value, their shares are inherently volatile. Real earnings can rescue a regular stock from a downturn, but a PBC’s shareholders have no idea how much of those earnings they own.
Putting PBCs into indexes foists them on unsuspecting investors. Millions of Americans entrust their savings to the capital markets for the sole purpose of increasing their wealth. They rely on asset managers, corporate boards and management to maximize shareholder value. When they want to give to charity, they do so. Transferring wealth from shareholders to whatever corporate boards perceive as a public good amounts to little more than a tax on 401(k)s; doing it without the owner’s consent is tantamount to theft.
Index providers should ban PBCs from broad-based indexes. There’s a precedent. In 2017 S&P and several other large index providers updated their methodologies to exclude companies that have a multiple-share-class structure, reasoning that the restricted voting power of nonpreferred stock doesn’t put shareholders’ interest first.
Action Line: There are many mistakes you can make with your money. Allowing someone to use it for their own personal political crusade that you don’t even agree with is one of them. Click here to download my free special report on the Top 10 Investing Mistakes to Avoid.
E.J. Smith - Your Survival Guy
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