Jeff Ubben Explains His “Anti-ESG ESG” Investment Strategy – Kellogg Insight

Jeff Ubben co-founded the hedge fund ValueAct Capital in 2000. Twenty years later, he left to form a new fund, Inclusive Capital Partners (“In-Cap”), focused on impact investing. Throughout his career, he has favored an active approach to investing. But in contrast to other prominent investors like Carl Icahn, known for proxy battles and hostile takeovers, Ubben prefers to be invited into the boardroom, partnering with big shareholders and management to reform firms from the inside.

Today, Ubben holds a board seat at Exxon Mobil, among many other organizations. He is also a member of the advisory council for Kellogg’s Asset Management Practicum. Ubben recently sat down with Robert Korajczyk, a professor of finance at Kellogg. The pair discussed Ubben’s investment philosophy, his pivot to mission-driven investing, and why he believes that an exclusionary approach to ESG is misguided. He also explained why his fellow investors can be the biggest obstacle to investing in green technologies.

This interview has been edited for length and clarity.

KORAJCZYK: I know you don’t like the moniker “activist investor,” so is it fair to say you’ve evolved to a “governance-based” approach to value investing?

UBBEN: “Governance-based” is a good way to think of it.

Earlier in my career, the mutual fund industry didn’t want to go after companies. Oftentimes you had ideas on how the company could do better, and the management team would say, “Well, if you don’t like what we’re doing, you can sell the stock.” That was a bee in my bonnet.

As a value investor, I also had the problem where I’m waiting for lightning to strike. Like, what is the catalyst? The company that I’ve invested in is cheap, it’s got intrinsic value, but what makes the market appreciate it or find it?

Those factors lead me to co-found ValueAct Capital, where the owner had a voice. But my approach is not to use that voice from the outside, but to do it from the inside and to really work with management as part of the board. The beautiful place is when your strategy becomes management’s strategy, and they just execute as opposed to both sides yelling and screaming at each other—or you going straight to the media and hijacking the work and the story from the company itself.

KORAJCZYK: You want to avoid taking an Ichan-esque approach.

UBBEN: Yeah. In some cases, a company was going to do something themselves, but now it’s the activist’s plan. Well, how would you like to be the management team?

The problem with that strategy is that your ability to be effective if you do get into the room is lower than the way I do it, which is, we get to know each other. Once I’m in the room, we’re going to figure this out together, and then we can high-five together.

KORAJCZYK: To get a board seat, you obviously are taking very concentrated positions. But does it also take some coordination with, let’s say, a mutual-fund complex that agrees with you to get you enough votes for a seat?

UBBEN: I’ve never done a proxy contest. I started down the path of one in 2005 with a company called Acxiom, and we ultimately settled before the actual proxy contest (we got the board seat we were seeking), and it was not the best experience. We may have won the battle but lost the war—we lost money on our investment in the company. I was having to explain what I was going to do with this company before I even knew the company very well. When I got in the room due to a settlement, I thought the CEO didn’t trust me—as I would’ve expected. Without his confidence, I was just much less effective.

That taught me to earn the trust of the big active shareholders—which I spend a lot of time doing—whom I can call when we’re trying to affect change. I had to act constructively in the boardroom so that they could say, “He’s tough, but he listens, and I would recommend him as a board member.” Because I don’t want to force myself into the room. I want to earn my way into the room. That’s where I put my energy and my focus.

KORAJCZYK: Do you have a favorite example from your time at ValueAct of how recruiting other shareholders can pay off?

UBBEN: When Microsoft needed to open up its productivity suite to iOS and Android, I thought Steve Ballmer was too much of a monopolist: he had everything captive to the Windows operating system. The company needed new leadership.

When we called the board members, they were like, “You own 1 percent of the stock! But what you’re saying is interesting. We haven’t talked to shareholders before, and we didn’t know that we could get Steve out.”

We then reached out to big shareholders and got them to call the board members to indicate that they also supported the change. That worked. I think in the end 20 to 25 percent of the shares weighed in with the board, and the board acted with confidence to let Steve go. That’s just so much easier than a proxy contest, which can be costly for all involved, with both sides digging their heels in and both feeling like they’re attacked and fighting back.

ValueAct had a reputation for not being a “hit and run” activist. We were going to stay there and really create sustained value working with management and the board.

KORAJCZYK: It’s important in a governance-based approach to really know the business.

UBBEN: Yeah. It’s our day job. It’s our day job just to study the company. And then, when you join a board, you bring new information to the room. So we come into the room with our own information, we learn from them, they learn from us, and then working together, we get it right.

Because you also have these biases. You’re like, “That business is the bad business. It needs to be spun out.” Then you get in the room and the business you thought should be spun out needs more investment rather than less investment. It is a two-way street.

Then the window opens for all directors to buy shares if they’re so inclined. The earnings have been reported. The long-term strategy has been communicated. Counsel says I can buy more stock, and I do. Most activists don’t get to that promised land because basically they are there for a transaction, a specific reason: split the company up; sell the company.

KORAJCZYK: Can we talk a little bit about your evolution to thinking about social impact and developing the Spring Fund at ValueAct and then starting In-Cap? How did that come about.

UBBEN: There are so many layers to this!

First, I’ve been married for 38 years, with my wife raising the kids and me just working, working, working. Then the kids leave the house. It just didn’t seem workable that I would continue working away at stuff that was uninteresting to her. We’d have dinner and what would we talk about? My wife is a conservationist and an animal activist. By 2017, when I was handing the portfolio off to my younger partner, I was going to have to find something to do. It made me think, is there a way to bring my investment mind to her passions?

Second, at ValueAct, there was our investment in Valeant Pharmaceuticals. After many years of being invested at Valeant, the company had something like a double-digit price–earnings ratio, back when that was a lot. I thought there was just no way the organic growth in the business could justify that, but it was our responsibility to continue to drive shareholder value. The only thing to do is to keep growing and use more debt and do bigger deals and cut more costs after doing the deals. I think that reward cycle does tremendous damage to the workforce, because every time you buy a company, you may have to lay off employees because you need to find the earnings. It doesn’t do the customer well because you’re raising prices when you can. Valeant wasn’t any worse than many other companies—but it became politicized during the 2020 Presidential election. In addition, it was a on a “do bigger deals with more debt and cut even more costs” hamster wheel that you couldn’t seem to get off of.

Which leads me to this third reason for moving into impact investing, which is, where’s the next 20 years of high returns? I don’t think it’s from “rinse-and-repeat” financial engineering, and that’s what M&A, share repurchases, and cost-cutting are.

That wasn’t always the case. In the early 80s, there were mid-teens interest rates. Finance was scarce, but social capital was long. We had a really robust middle class. The natural capital was infinite. Nobody was talking about constraints.

Today we have tremendous societal inequities. The middle class has been hollowed out. We don’t pay a fair wage. Uber somehow is the ultimate [expression] of capitalism: We take a person that doesn’t earn a fair wage. They have to work a second job. They have to put up their own capital, which is their car that they own themselves, which depreciates. Then they compete with other people that are looking for extra income to pay the bills, and their boss is an algorithm. I don’t think there’s any way that can be sustained. There’s going to be a revolution.

Then of course, I live in California where there’s no water. We grow all the fruits and vegetables for the whole country. What does that mean? The planet’s saying, “Whoa, what’s going on here?” These environmental and social goals, which are much longer term in nature, are the new value drivers. If you allocate well against scarce resources and do it early, and you do it big, and you figure it out, that’s where the big companies are going to come from. There’s the return piece I was looking for.

I formed the Spring Fund, named after Rachel Carson’s book, Silent Spring. I started with my own money. The first investment we made was a coal-power producer, a company called The AES Corporation, a 40-year-old company. Their stock had recently depreciated. The problem wasn’t the performance of the business. I thought they actually had a really good cash-flow stream. They could pay a big dividend. The earnings were growing. The problem was that the externalities were starting to impact stock prices. I then had something to work with. I needed that low stock price to be a catalyst for change.

I approached the company after six months of work. I said, can I join your board? They said, yes, we’d love you to be on the board. I said, “Let’s be the first Western utility to file according to Task Force for Climate Related Disclosure,” and we did.

According to our own company report, we still produced too much coal in a world that needed to be Paris-aligned. That report alone caused the company to essentially get out of coal. AES innovated around a new product called “green, blend, and extend.” AES would come to utilities or mining companies and say, “Okay, we have these capabilities in renewable energy. We can run your coal plantless and therefore reduce emissions. We can buy excess energy in Chile in the middle of the day from renewables, and we can pass on those savings to you. We’re going to lower your costs. In exchange, I want you to write a new power-purchase agreement when our contract ends in five years that’s 100 percent renewables.” Now I think AES is a leading developer of renewables in the U.S.

I think AES got tremendous recognition in its stock price that it is a company of the future rather than a company in the past.

I was onto something. Spring Fund started taking outside money, and eventually I left ValueAct to form In-Cap and focus on mission-driven investing.

KORAJCZYK: Wow. With AES, and now with you being on the board of Exxon, I wonder if you are having some interesting, or maybe difficult, conversations with some investors. At most universities, for instance, there’s a push to do what I consider negative screening: “We don’t do this. We don’t do that.” What happens when you go to a potential investor, and they say, “Wait, you’re investing in fossil fuel?”

UBBEN: Many potential investors ran away from me. I am the anti-ESG ESG strategy. That proved not to be an ideal marketing strategy.

KORAJCZYK: What’s the logic behind your anti-ESG ESG strategy? Why do you feel your strategy is preferable to one based on excluding industries like fossil fuels?

UBBEN: I think the already-green companies are overvalued, and the not-yet-green companies have been divested or ignored.

But an exclusionary strategy doesn’t work either. You can’t do nuclear. You can’t do biomass. You can’t do fossil fuel. You can only do wind and solar—which by the way, doesn’t have the energy density that we need. A billion dollars of oil and gas investment generates about 25 terawatt hours a year of energy. A billion dollars in solar and wind investments generates significantly fewer terawatt hours a year of energy, is less energy dense, and is more capital intensive! I’m totally willing to make this energy transition in a way that’s responsible, but let’s tell people: when you decarbonize your business, it’s extra cost.

If we could use the existing hydrocarbon infrastructure for as long as possible and decarbonize it through things like carbon capture and blue hydrogen, and then layer in the new technology and start to put a carbon price into product prices, I think we can get to the promised land. There is a path. We need to get the carbon that goes into the atmosphere down to the point where we can start taxing it and it doesn’t kill the economy.

But the worst thing is this unjust transition that we’re going through now, which is you reduce supply, but you don’t affect demand through policy because our politicians are too scared to do it. The oil price increases significantly, which harms the middle class, and it’s all profit to the hydrocarbon companies, and it elicits even more supply.

If you were taxing carbon today, the price would already be so high and it wouldn’t be going to the hydrocarbon companies. It’d be going to the government that could then redistribute it.

But there’s no return right now attached to carbon-capture investment. Nobody’s paying for the carbon capture yet. I want to invest in carbon! But investors are like, “But there’s no return.” The fact of the matter is because it doesn’t have a current return, it’s not worthy of capital. Investors would rather do a share repurchase, which I think is the worst use of cash in a capital-intensive industry that’s going through transition.

I used to believe, like Buffett, that you’d rather buy a great business with mediocre management instead of mediocre business with great management, because the business wins in the end and you can change management.

In the new world, these CEOs do want to be part of change. They do want to reallocate their capital to these long-term societal imperatives. Now with my new hat on, instead of replacing CEOs, I have to “fire” existing shareholders. I have to tell companies, “Stop paying the big dividends. Reinvest in decarbonization technologies. Let’s go find all the other new investors that want to support this company as a carbon-management company.”