Introducing Anti-‘ES’G smallcase by Stalwart Advisors


Excesses at one end often create opportunities at the other, which can be leveraged by pragmatic investors.

Environmental, Social & Corporate Governance (ESG) theme has gained tremendous momentum over the last few years with billions of dollars flowing out of companies that score low on some arbitrary parameters, to the companies that score high. In simple terms, it is a framework to rate businesses on how good are they for the environment, society and whether they have sound governance. On paper, this is certainly a desirable concept, but in practice it is extremely subjective with rating frameworks as well as corporates, trying to manipulate the system to suit their beliefs and situations. Investors are made to believe they can make excess returns while morally feeling good about it. The money managers are happily playing along.

ESG proponents love Electric Vehicles but hate thermal energy while missing the irony, that the electricity that powers the EV is still mostly produced by burning coal. FMCG giants are rated high on ESG, but, in reality, they are responsible for most of the single-use plastic waste (packaging) that gets dumped in the ocean. It is without a doubt that sustainability should be our priority today, however, punishing producers of essential commodities will not solve the problem unless we find viable & reliable alternatives. Ultimately, the unit economics will prevail & consumers will bear the cost.

It is natural for individuals to have preferences emanating from their background, religion, culture, or family. Some apply that to investing too – like avoiding stocks of companies selling sin goods or those involved in animal cruelty. Practicing a moral code at the individual level is one’s fundamental right, however, the idea that this extremely subjective & complex system can be institutionalized via a rating framework across the globe, which will then be adopted uniformly by corporates as well as money managers, is certainly a stretch.

Liquidity has the power to drive short-term price movements through expansion or contraction in valuation i.e. earnings multiple (PE), however, it is the earnings & cash flows that determine the intrinsic value of the underlying business (present value of future cash flows). Value doesn’t depend on any ESG rating or perception of a certain class of investors.

The outflows from these so-called Anti-ESG stocks have beaten some of them down to ridiculous valuations. The demand for these stocks is down, however, the demand for their products & services continues to rise, while the incremental supply is low in the wake of ESG Revolution and the rising cost of capital for such companies. This could make the existing assets all the more valuable. Some of these assets are of national importance for they ensure energy security, grid stability, self-reliance etc. There is certainly a terminal value risk to some of these businesses but cash flows over the next 5-10-15 years are real & justify the ruling valuations.

Excess of even good things tends to have bad implications. We believe ESG could be one such ‘good’ thing. The pendulum has swung far too much towards ESG and while it will certainly not come back fully to Anti-ESG, but even a rebound to the center has the potential to create disproportionate returns for opportunistic investors.

Some common phrases used to describe these assets are ‘Melting Ice Cube’ or ‘Cigar Butt’ but even melting ice could be used to cool a glass of beer while a cigar butt still has a few puffs left hence should not be discarded altogether.

Being a contrarian doesn’t imply one needs to drive on the wrong side of the road & invite trouble. In this Anti-‘ES’G portfolio, one factor which we wouldn’t bypass is G (Governance). Anything multiplied by zero is zero and in case management can’t be trusted, no price is a good price – this isn’t some wishful ‘chor-bane-mor’ basket.

Our universe consists of about 50 businesses punished unfairly on ESG ground. These are otherwise attractive businesses that score decent on most key parameters of market leadership, balance sheet, operating cash flow, growth potential, capital allocation as well as corporate governance. We have shortlisted select mispriced opportunities from this universe to make a smallcase which we will keep updating at quarterly intervals.

The basket is worthy of being a satellite which typically implies upto 20% allocation based on individual risk appetite. It is a contrarian’s delight as risk-reward is favorable – Heads we win big, tails we don’t lose much.

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2 responses to “Introducing Anti-‘ES’G smallcase by Stalwart Advisors”

  1. Rajeev Avatar

    This concept is good. When ESG based investing was launched I discarded it as a mere tactic for AMCs to launch more of the same products. This is a just a fad which will fade with time.

  2. Rajeev Avatar

    Very rightly pointed out. ESG just has too much hype with no proper backing.

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