The Commonsense Capitalism of Chris James

Christopher James (Illustration by Jonathan Bartlett)

Christopher James

(Illustration by Jonathan Bartlett)

Engine No. 1’s victory in a boardroom battle with ExxonMobil is taking ESG investing to the next level.

Chris James might seem an unlikely person to become the most prominent ESG investor of 2021.

The founder of Engine No. 1, a small investment firm whose David and Goliath boardroom victory over ExxonMobil stunned the financial world this spring, was born and raised in the coal mining town of Harrisburg, Illinois, where his family and that of his wife — also a native — have long-standing ties to the industry.

When James was growing up, Harrisburg was a vibrant working-class city. But by the time he graduated from high school, he says, “it was kind of falling apart. Not only did you have the environmental impact of a coal mine shutting down, but we had a hat manufacturer close to downtown that employed a lot of people, and that company moved to Mexico.”

James, who has been in the hedge fund world for decades, has traveled far from Harrisburg. But its realities have informed the economics-determined path that he and Engine No. 1 are taking.

The 52-year-old had a plainspoken way of describing the tension surrounding the issue when he spoke with Institutional Investor in August.

“You are concerned about environmental issues after you put food on the table,” a plaid-shirted James told II via Zoom from a log cabin on a ranch in Wyoming, where he had gone for a reunion of his wife’s family — salt-of-the-earth types, descended from coal miners, who still work with their hands. One is a welder for a pipeline.


Such blue-collar workers might be expected to be on the other side of the environmental divide. But although the debate about paychecks — and profits — on one side versus environmental and social change on the other is decades old, James says it doesn’t have to be that way.

“These skills are very transferable,” says James, who once opened a coal mine near his hometown, then sold it as the business suffered.

The downward trajectory of the coal industry could be viewed as, well, the canary in the coal mine for the future of fossil fuels. Yet the notion that saving the planet will hurt the corporate bottom line has kept many hard-nosed institutional investors away from environmental, social, and governance investing. After all, their fiduciary duty is to make the highest return possible — regardless of the cost to society.

For years, that made ESG what James calls a niche strategy for liberals who want to use their pocketbooks to vote their values.

Along with the team of 39 other people who’ve joined Engine No. 1, James aims to help change that perception and take ESG investing to the next level by showing that adhering to its principles is actually good for business — in the long run. He says that’s not the case only for the environment. It also goes for social issues such as a living wage and racial diversity. Engine No. 1 may well tackle those issues in the future.

The scrappy investment firm has about $430 million now, which includes $240 million of internal capital in its hedge fund. James declines to discuss fundraising efforts, but how big of a haul the firm is able to make off its ExxonMobil success may determine how quickly it moves into other areas. It has launched a $100 million exchange-traded fund that owns stakes in 500 companies and could be a partner in future ESG activist proxy campaigns by voting its shares in support of new directors or proposals. The ETF’s assets have already grown to $184 million. Next, Engine No. 1 plans to invest in private companies and is eyeing several projects.

Not all of its engagements with public companies will end up in proxy fights. This week, Engine No. 1 announced an investment in General Motors, based on the automaker’s enhanced efforts to go electric. “GM’s goal to go 100 percent electric by 2035 signals one of the largest transformations in the history of the auto industry,” James said in a statement announcing the stake, revealing that the firm has had “constructive and collaborative” discussions with GM.

But it’s the success with ExxonMobil that has caught the world’s attention at a time when the need for big, bold action to combat climate change has never been more urgent.

Consider this summer’s headlines: Extreme flooding submerged an entire town in Germany, wildfires burned out of control in the American West, and one of the most powerful hurricanes ever seen rolled up the eastern seaboard of the U.S., creating a state of emergency in New York City just weeks after the United Nations released a scientific report claiming that it’s too late to stop global warming. Even if carbon emissions are cut now, the U.N. says that will simply cap the increases that are already baked into our future.

Instead of talking about such horror scenarios when making the pitch for change at Exxon, Engine No. 1 used a classic shareholder activist tactic: It focused on the oil giant’s performance, which had been lagging its peers as the company insisted on investing in fossil fuels when doing so appeared to be a reckless economic proposition.

“Exxon was really locked into a singular demand scenario where oil would get to high prices and stay there for decades to come,” says Charlie Penner, the architect of Engine No. 1’s Exxon campaign. He cut his teeth on activism at Jana Partners, the hedge fund founded by Barry Rosenstein, and now heads active engagement at Engine No. 1. The collapse in demand for oil during the Covid-19 pandemic made things worse for Exxon; it lost $22 billion in 2020.

Optimists think Engine No. 1’s prevailing over Exxon is a harbinger of more action ahead. “The thing with Engine No. 1 is going to spread,” says Andy Behar, a longtime activist and CEO of As You Sow, a nonprofit organization dedicated to increasing environmental and social corporate responsibility through shareholder advocacy. “You’re going to see board slates being run at dozens of companies next year. Companies who say ‘We’re going to ignore climate,’ the boards are going to be replaced. It’s just that simple.”

James, who has been talking with institutional investors since the campaign’s success, is a little less sanguine in his assessment of the landscape. “Most organizations, especially investment organizations, as they’re trying to figure out ESG, they’re looking at it through a more ideological lens without realizing that these criteria are important determinants of performance, of an ability to create long-term value,” he says. (Engine No. 1 calls its approach a “total value framework.”)

Sighs James: “I still feel like linking ESG criteria to outcomes is an uphill battle.”

The founder and chairman of Engine No. 1 likes to say he is putting common sense back into capitalism.

It took him decades to come to that idea. After leaving his hometown, James studied economics at Tulane University in New Orleans before moving to New York City to work in finance. He eventually relocated to San Francisco, where he became a prominent hedge fund manager investing in technology stocks. He co-founded Andor Capital Management in 2001, then left in 2004 to start another hedge fund, Partner Fund Management.

Like many wealthy hedge fund managers, James also wanted to give back. He was one of the founders of Tipping Point Community, a nonprofit organization fighting poverty in San Francisco.

Tipping Point focused on the issue of San Francisco’s homelessness, but it kept getting worse. The more data the group gathered about the root causes, the more James began to realize that his peers were part of the problem. Tech companies that were booming in the Bay Area “owned a large part of the responsibility for homelessness,” he says. “When Google’s hiring 2,000 people, a quarter of them in San Francisco, it’s literally squeezing everybody else out.” Several studies have shown that cities with the highest rents also have the highest levels of homelessness.

James says this “cognitive dissonance” between his work and his philanthropic activities eventually led him to reject the model he attributes to Andrew Carnegie, the 19th-century industrialist. Carnegie was known for his brutal business practices, culminating in the bloody Carnegie Steel strike of 1892, as well as his many philanthropies, including the creation of public libraries around the country.

In simple terms, James says, the Carnegie model is: “I’m going to make money over here; I want to give money away over here.”

So he went back to school — sort of — and it was an eye-opener.

“For a long time, I thought, ‘Okay, companies are doing what they should be doing in terms of maximizing profits,’” James says. “But then as I read more on this stuff, I’m like, ‘It’s over a very short duration.’”

He delved into “a bunch of geeky white papers” that looked at the social value of business, including writings by Harvard University professors Michael Porter and Sir George Seraphine and the University of Chicago’s Luigi Zingales, all advocates of ESG and impact investing. That social value, James says, is “profits minus the damage that [companies] do.”

He continues, “I eventually came to the conclusion that companies should really clean up their messes. They should take responsibility for their impacts. It’s really a commonsense argument, but it isn’t a popular view for companies.”

In 2020, James began to put together a new firm that would embrace this philosophy. One of his first recruits took him across the country to New York City. There he met with Penner, who was already engaged in impact investing at Jana, which had had some early success: In 2018, Jana and the California State Teachers’ Retirement System teamed up to urge Apple to take steps to stem smartphone addiction among children, and the tech giant quickly responded.

By the fall of 2019, Penner had set his sights on bigger fish. He wanted to run a proxy battle at Exxon, which was not only the biggest climate change denier among the oil majors but was also suffering from its overinvestment in fossil fuels. But it was a struggle to raise money for the effort.

Then Covid shut down the global economy.

“Covid was a real turning point . . . everybody sheltering in place. It’s like we were in a cocoon, and in that year, we metamorphosized,” says As You Sow’s Behar. “We saw Black Lives Matter. We saw racial justice out on the streets, people risking their lives with Covid, people saying, ‘I’ve had enough. I need change.’”

The numbers more than bear him out. In 2020, ESG funds took in $51.1 billion. That was more than twice the $21.4 billion in 2019 and nine times the amount invested in 2018, according to Morningstar.

And despite its newfound popularity, Behar insists, “ESG is not a fad.” He agrees with Engine No. 1 that “it’s good business.”

Behar explains that “ESG means less risk. It’s the whole idea of, if you take care of your employees, if you take care of your environment, if you take care of your supply chain, you’re going to have less risk in your company. The companies that actually have good environmental, social, and governance policies and practices are simply less risky. They’re not going to get sued as often. They’re not going to have as many environmental violations, they’re going to attract the best and the brightest in terms of their employees, they’re going to retain their employees.”

As ESG investing has grown more fashionable, however, allegations of greenwashing have also emerged, with critics accusing funds of merely sticking an ESG label on an offering and tweaking the holdings slightly to charge higher fees.

Engine No. 1’s brand of ESG is different from the vast majority of the available investment products with that label — and that is fortunate, as regulators are now starting to pay attention to the proliferation of such products.

Earlier this year, the Securities and Exchange Commission sent out letters to investment advisers asking them to “describe in painstaking detail the screening processes they use to ensure assets are worthy of ESG designations,” among other demands, Bloomberg recently reported, noting that the SEC has a whole task force dedicated to the effort.

Last month, The Wall Street Journal reported that the SEC and the Department of Justice are investigating Deutsche Bank’s asset management arm for “overstating how much it used sustainable investing criteria to manage its assets.”

According to Tariq Fancy, a former BlackRock executive who was in charge of sustainable investing there between 2018 and 2019 and is now focused on what he sees as the hypocrisy in the ESG world, “If there’s zero regulation at all on what constitutes green or sustainable, the impetus is to do the least amount to change your underlying product, while getting the green stamp because there’s a race for everybody to say it’s green.”

Although he didn’t speak to the Deutsche Bank situation, Fancy details the problem that he saw as a practitioner.

“You get into the weeds, and first of all, they’re just overweighting tech and underweighting fossil fuels. Then they’re going out and cherry-picking the data, saying, ‘Look, this means that ESG products do better,’” he says.

A true believer in the principles of ESG investment when he joined BlackRock, Fancy now thinks that not only do ESG products do nothing to help the planet, they actually hurt it by convincing investors that they are doing something good when, he says, they are not.

In his mind, only government intervention, in the form of a carbon tax, will stop polluters like Exxon. “If there’s no tax on pollution, then ultimately, fossil fuels are still very competitive because no one pays the cost of pollution,” he says.

Companies “will only be forced to like clean energy if they’re forced to pay the cost of the pollution,” he adds. “If you have a carbon tax, then the market will adjust, and it doesn’t matter if you’re Republican, Democrat, you’re a climate denier or whatever, you’re going to just adjust your capital accordingly. But if there’s no price on carbon, there’s no fixing the greatest market failure in history. Then the underlying activity is still profitable. Money’s going to find it.”

Fancy is also critical of Engine No. 1’s activist campaign at Exxon as “another ‘free market corrects itself’ mechanism. I’ve got to worry that these things are all placebos.”

The political arena in the U.S., however, has been less than responsive to change, in part owing to the massive influence of the fossil fuel industry. That means the market has had to step in.

“I am less optimistic that the government can handle this alone,” says James. “I mean, look at climate change. What has had the biggest impact in reducing carbon emissions in the U.S. has been the market.”

Adds Penner, “Can we be a complete solution? Of course not. But nobody can be. No investor, no country can be a complete solution, but if you have an understanding of the kind of complexity of the landscape and how the pieces work together, you can play a very positive and value-creating role.”

For Engine No. 1, the issue may boil down to how much Exxon’s new board can move the needle. “The board has a fiduciary duty to shareholders,” Fancy says, arguing that if the underlying business activity is still profitable, the board is unlikely to rock the boat. “The only thing that’s going to change that behavior is if you make it less profitable to do the harmful activity.”

Environmentalists and investors say the data is proving him wrong.

During its proxy battle , Engine No. 1 argued that Exxon, the world’s fifth-largest producer of greenhouse gases, faced “existential business risk” if it hit the goal of net-zero emissions by 2050. The activist fund said the company needed to change in order to survive — though it may take a decade to do so. At the same time, alternatives are becoming more cost-competitive and other oil companies are moving faster in making the transition to clean energy.

Meanwhile, Exxon’s revenues and return on capital have been declining for years. With the company’s breakeven cost of oil above $80 per barrel pre-Covid, it’s hard to see how its profits will come back if it continues down the same path, according to Engine No. 1, even if oil prices go up.

By focusing on the traditional financial metrics of stock price and capital allocation, Engine No. 1, with its analysis and slate of candidates, won the early support of several big institutional investors, including CalSTRS, the California Public Employees’ Retirement System, and the New York State Common Retirement Fund — even as the firm itself held only a $40 million stake in Exxon. In addition, BlackRock, State Street, and Vanguard — all proponents of ESG — voted their shares for three of Engine No. 1’s candidates, who now sit on Exxon’s board.

The small investment firm also garnered the support of powerful proxy adviser Institutional Shareholder Services, which cast doubt on Exxon’s stated efforts to stem fossil fuel emissions — a point that was brought home this summer when a widely reported undercover video by Greenpeace activists showed Exxon’s Washington lobbyist saying that the company would not support a carbon tax and was working to thwart President Biden’s climate initiatives.

Changing the culture at Exxon will be an uphill battle, as the folks at Engine No. 1 realize. “It’s very insular,” notes James.

But the talent pool of engineers is there, and Engine No. 1 has started the conversation. “You can make arguments that touch on these environmental and social issues, as long as you draw a very strong connection to why those issues matter to shareholders,” Penner says. “We couldn’t just show up and say, ‘Hey, you’re destroying the planet. Stop it. Vote for us.’ Right? That’s not a campaign.”

Penner argues that the new board members can help steer Exxon into new sustainable-energy technologies and “get them to have a means to actually have a future in the energy transition, which might even change their incentive to lobby against change.”

The board members chosen by Engine No. 1 are certainly an impressive group. Before the activists launched their campaign, no one on Exxon’s board except its CEO had any experience in the energy industry, which was a major point Engine No. 1 made when it offered new leadership with substantial experience in the field.

For example, one of its candidates, oil industry veteran Greg Goff, led a successful turnaround at Andeavor, a small refinery that was bought by Marathon Petroleum. Another, Andy Karsner, a senior strategist at the innovation lab of Alphabet (formerly Google), was the assistant secretary for energy efficiency and renewable energy in the Obama administration and is seen as a key link to policymakers. Last, Kaisa Hietala, the only woman in the group, is a former vice president at Neste, a Finnish petroleum company, where she led its transformation into renewables.

“The work on Exxon is the perfect case that movements have tipping points,” says Jennifer Grancio, CEO of Engine No. 1, who, along with Penner and James, was among the first employees the day it opened its doors last December. Others there at Engine No. 1’s launch include two who came with James from Partner Fund Management: COO David Swift and Edward Sun, who oversees the firm’s Perennial Total Value Fund.

Grancio was in charge of creating the firm’s first ETF fund, whose stock ticker — appropriately — is VOTE. A co-founder of iShares and formerly an executive with ETF responsibilities at BlackRock, Grancio says asset managers had been looking at how to build ESG products as long ago as 2014. “The sense was the market’s not buying it,” she recalls.

“Now I think everybody is coming around to the point of view that you need to take these issues into account. We’re not going to have a planet or a society if we don’t, but also just for economic reasons you have to take these issues into account,” she adds.

Engine No. 1 argues that the second generation of ETFs, like the one it just launched, have better data to work with than the earlier versions did.

“There has been this data revolution in the last 20 years where we have data on everything. We now have the data behind water use or carbon emissions for many of these companies. But there hadn’t yet been a way in which people incorporated this data into their investment framework,” notes James.

With regard to ETF products, Engine No. 1 is on the same page as Fancy, who claims, for example, that divestment is “ludicrous” — even though a few prestigious institutions, like Harvard’s endowment, have gone that route. He also charges that lowering the amount of fossil fuels in a portfolio is “soft divestment.”

Says James, “ESG funds that do negative screening don’t own oil and gas, or they don’t own Phillip Morris. There’s no real change that happens as a result. It’s the ‘I’m going to buy this because I won’t feel guilty’ approach. That’s the first stage of that movement. I don’t think that’s the sustainable way to effect change.”

He continues, “If everyone had divested to make themselves feel good, we never would have gotten three people on the board of Exxon. Who would have voted for us? We really want to push this idea that votes are powerful. People should put their mouth where their money is.”

So what’s next for Engine No. 1? First will be a private investment that is likely to be a company with an environmental impact, but James is reluctant to discuss it in any detail. “We just want to be a partner with people who share the vision and really want to move the ball forward,” he says.

Engine No. 1 is not focused solely on environmental concerns, however. Both he and Penner are passionate about the concept of a living wage, which is what initially drew each of them into the world of impact investing.

Penner became interested several years ago following the strikes by fast food workers who launched the living-wage campaign for $15 an hour. “It dawned on me that if you took the long-term investor’s perspective, there was a much stronger argument for actually paying people a living wage,” he recalls.

Even though a company might take a hit at the outset, he says, “over the long term, in terms of improved customer service, reduced turnover, reduced shrink, more money flowing back into the community and coming back into the stores, it all made sense.”

James, meanwhile, was drawn in by the living-wage idea when he was looking at data that Tipping Point had collected, showing that children who weren’t reading at a third-grade level were more than twice as likely not to attend college. Why weren’t the children hitting that reading level? “Their parents weren’t earning a living wage and had to work two jobs, so the kids missed, on average, 30-something days at school. But if you miss 30 days of school, the chances to be at a third-grade reading level were approximately 15 percent. So you could literally trace the non–living wage earned by a single parent back to kids having a very low chance of making it to college.”

Engine No. 1 now has a team of data scientists focused on research in this area. “Every year, the data gets better,” says James. Although the research is still a work in progress, he notes, “we believe in living wages. We think companies should be responsible for their workers. They should pay their health care. The idea of having to work two or three jobs just to keep food on the table, that just doesn’t pass the smell test.”

It seems like common sense, but will capitalists — and other investors — buy it?

Says James: “Our job is to convince people.”