Felix Salmon Isn't Buying What Al Gore Is Selling
The new issue (subscribe!) has my article on Generation Investment Management, the London-based financial firm Al Gore co-founded more than a decade ago. Generation has been very profitable, and Gore and his colleagues contend that its success should draw attention toward the rewards of environmentally conscious “sustainable capitalism.”
Felix Salmon, the prominent financial writer and senior editor for Fusion, has some thoughts about this piece, what Al Gore and his colleagues are up to, and what it all does or does not mean. As will become obvious, there are parts of Salmon’s letter I like and agree with more than other parts, and I think that many of his complaints boil down to this not being a different kind of article for a different kind of readership in a different, more financial-insidery kind of newspaper or magazine. Or by a different writer! Some other parts, I think, are versions of the “$20 bill on the sidewalk” outlook I mention in the article: the Gore/Generation practices can’t really be that successful, because if they were everyone would already have adopted them. (“That can’t be a $20 bill on the sidewalk, because if it were someone would already have picked it up.”)
But there are also some good fundamental questions he asks about the implications of this model, which I’m resisting answer piecemeal and will begin responding to tomorrow. For now, I’m grateful to Salmon for letting me quote it in full and kick off the discussion.
Felix Salmon writes:
This is a fascinating and yet frustrating article, at least for me. It’s by far the most in-depth thing that has ever been written about Generation, but I feel like it doesn’t really answer any of the questions I had about the company, most of which arose when I wrote this piece about why more investors don’t divest from fossil fuels. The Generation view would have involved me putting something in there about how solar is a much better investment than coal, or some such, but because Generation is so secretive about its results, I couldn’t really do that.
So anyway, here are my questions:
1: *How*, exactly, does the Generation model “shift the incentives of financial and business operations to reduce the environmental, social, political, and long-term economic damage being caused by unsustainable commercial excesses”? Is it basically just by saying to companies “if you behave this way, then we will be more likely to buy your stock”? It seems to me that whether or not Generation has done well for itself and its investors, there’s really no evidence at all that it has shifted any incentives even in the companies it invests in, let alone in the companies that it *doesn’t* invest in.
To take a big example, how, say, are Exxon Mobil’s incentives shifted by the the existence of Generation, and companies like it? The story says that Generation is “reducing the destructive side effects of modern capitalism”, but I don’t see any evidence of that?
2: The benchmark being used here is the MSCI World, which, fine, is as good a benchmark as any, I guess. (Although it ignores the bulk of all investable global assets, in that it includes no fixed-income bonds. Does Generation invest in bonds at all? Or anything other than publicly-listed stocks? From the story I’d guess not, but who knows.)
Still, you have to set your benchmark ex ante, not ex post. Did Generation say, when it was founded, that its benchmark was going to be the MSCI World? Because if it didn’t, this is basically the investment version of p-hacking. [JF note: More on p-hacking here.] The main benchmark that investors tend to use is the S&P 500, which has significantly outperformed the MSCI World over the past 10 years.
3: What is this Mercer “survey” on which the claims of outperformance are based? The piece annoyingly has no hyperlinks, even to things like public Andy Haldane speeches, so I’m unclear on whether the survey is even public. [JF note: I’ll try to restrain myself in general, but this doesn’t have links because it’s an article from the print magazine.] And is the 12.1% figure before or after Generation’s fees? How much is Generation charging for its revolutionary model?
4: More p-hacking: all we’re being told about here is the 10-year return of a single Generation fund, which may or may not be the one which is closed to new investment. Remember that because Generation is highly secretive about its results, it gets to open itself up to Jim Fallows on its own schedule, at exactly the point at which it can claim the best results. What we don’t see in the article is even a simple chart of the value of $1,000 invested in Generation: all we get is a single datapoint of the 10-year annualized return. Which is interesting enough, as far as it goes, but how’s the 5-year return? The 3-year return? And, more importantly, what are the *investor* returns, as opposed to the *investment* returns?
If I could only get one number from Generation, this is the one I’d be most interested in: what is the average annualized return per dollar invested with the company? Here’s my suspicion: that Generation launched with a small amount of seed investment from its founders and maybe a passel of other Davos Man types. (Big institutional investors don’t even tend to consider a fund for investment until it’s at least 3 years old.)
During its first three years, when it was very small, Generation managed to do extremely well — so well, indeed, that it was able to attract billions of dollars in institutional capital. (We’re told Generation has $12 billion in AUM, although investment firms have all manner of ways of exaggerating that number, and I’m not sure I believe it.) But in the years since — in the years in which it has been a multi-billion-dollar investment fund — Generation has not been able to replicate the results it had when it was small, and as a result, none of its institutional investors have seen the 12% returns that you talk about. Has Generation actually managed to prove that it can deliver above-market returns to investors? I’m still unconvinced on that front.
5: Talking of which: Why is the fund closed to new investment? Ambitious investment managers like Blood and Gore don’t tend to do such things unless there’s some kind of problem with the fund in question. Best case scenario is that the fund can’t scale: it works when it’s small, but not when it has real money. Worst case scenario is that the fund is just doing really badly, however well it did in the early years.
For that matter, what’s with the $3m minimum, not being open to normal investors, etc? If this is going to revolutionize capitalism, rather than just being a feel-good diversification play for the ultra-rich, why can’t all of us be part of it? And why is Al Gore, of all people, gating himself off from 99.9% of the population who might be interested in going down this road?
6: The noncommittal quote from David Rubenstein is golden. But isn’t it that case that the likes of Rubenstein have vastly more ability to actually change the way that companies are run than the likes of Blood & Gore? Rubenstein has almost total control of the companies he buys. He can run them as sustainably as he likes, with an eye to as many different bottom lines as he likes. He can change them in deep, far-reaching ways. Whereas all that Generation can do, really, is buy and sell stocks on the secondary market.
Even Larry Fink, with his trillions under management, can’t do much more than that: look how much of his company is iShares, for instance, and other passive investment vehicles which give managers essentially no discretion over what to buy and sell.
7: But also, Rubenstein is right about constraints. Generation is trying to make money by trading in and out of roughly 125 companies, all of which are, to a greater or lesser degree, “sustainable”. That’s great. But what would happen if it then gave itself the *option* to trade in and out of other companies which are *not* sustainable? That option has some value, no? Would it not help if Generation understood Exxon Mobil well enough to be able to short it, rather than just taking long positions in its cleantech competitors?
8: There’s lots of talk in this piece about the problems of short time horizons, with a hinted implication that Generation’s time horizons are long, or at least longer. But some numbers would be really helpful here. Are Generation’s time horizons longer than any other institutional fund manager? How long does Generation hold on to its positions, on average, and how does that number compare to its more conventional competitors? That kind of thing. I’m perfectly willing to believe that Generation’s *analysis* involves a long-term outlook. Almost all stock analysis does. But does its investment behavior reflect that?
9: There’s also a bunch of talk about inequality, and wealth disparity, and that kind of thing — but how does running billions of dollars for major institutional investors, and delivering above-market returns on those billions, *decrease* inequality? Surely the more successful Generation is, the richer rich people like Al Gore become, and the more that inequality goes up.
10. It seems obvious to me that Gore’s job at Generation is the classic chairman job of asset-gathering. He’s not picking stocks, or making buy or sell decisions, or anything like that: he’s a sales guy, trying to persuade huge institutions to give him some of their billions. He’s also had ten years to perfect his sales pitch. When faced with a guy like that, you naturally need to have a certain degree of skepticism about what he’s selling, unless you can independently come to the same conclusions.
But it seems to me that Gore has almost complete control over what he chooses to reveal about Generation’s results, when he chooses to reveal it, and what he keeps secret. No one can do the kind of independent analysis on Generation that Generation does on the companies it invests in. Or if they can, they can only do so under strict NDAs. I’d love to know whether you talked to any of the investors in Generation, to see whether they are actually as happy with Generation’s returns as Gore would like us to think that they are. [JF: OK, I can’t resist on this either. Yes.] Or, better yet, whether he talked to anybody who kicked the tires and decided *not* to invest.
11. How does the actual business of buying and selling work? This is incredibly vague to me. The only example in the article is that of Kingspan, where we’re told that Generation bought 5% of the company in 2007, and then bought more and more stock when it got cheaper. Which implies to me that it should have well over 5% of Kingspan right now — but a quick Google search shows that in fact it only has 3.87%. Did Generation cash out when its investment became profitable? Did it even make money on Kingspan? I’m very unclear on what the Kingspan story is meant to be telling us.
12. There’s a lot of mean stuff written in this article about other firms on both the buy side and the sell side, and how short-termist they are, and how obsessed they are about stock price, and how their live events and conferences are incredibly narrowly focused, and stuff like that. But of course no names are named, at least on the buy side, and I do wonder how much of a straw man this is. The investors I know tend to spend a very great deal of time looking at long-term trends and the like, while it’s obvious to me that Generation, just like any other shop, has traders who are ultimately in charge of buy and sell decisions and who Jim probably didn’t talk to at all. Is Generation really all that different? Isn’t compensation based on 3-year performance, for instance, pretty standard for this kind of company?
13. In any event, even if Generation and investors like it do succeed in getting above-market returns from long-term investments in sustainable companies, how does that change anything? If you’re a long-term investor, after all, then pretty much by definition you’re not a marginal price-setter; that’s always going to be a short-term hedge fund or algobot. The effect on companies’ share prices is going to be de minimis, and the effect of companies’ share prices on the planet is going to be even smaller. I really don’t see how a tweaked investment strategy for rich institutions is going to Reform Capitalism, let alone change the planet, or reduce inequality, or anything like that. I mean, Al Gore is (sorry) no Warren Buffett. And even Warren Buffett hasn’t really changed anything!
Thanks to Felix Salmon for a bracing kickoff to a discussion. Stay tuned for more.