Who doesn’t love solving climate change? Green initiatives have been on the rise, with even Big Oil pushing green initiatives (ie. ExxonMobil and Pioneer Natural Resources). This all seems great, but how effective are some of the solutions? Especially with the addition of Biden’s Inflation Reduction Act coupled with the adopted SEC climate disclosure rule, startups and firms alike are all trying to take a piece of the incentive. In the giant macro trend toward sustainable investing, are we getting swept up by bandwagoners and false green initiatives?
The Rise and Fall of ESG
This question stems from the recent controversy of ESG or Environmental, Sustainable, Governance. The idea of ESG was first introduced in the 2006 United Nations Principles for Responsible Investment report. At the time, 63 investment companies signed with $6.5 trillion in assets under management (AUM) incorporating ESG issues. These issues involved growing corporate responsibility in ESG’s three pillars. ESG metrics became attractive to companies, given that slapping “green” or “sustainable” on the front page of your business is a great marketing strategy. As of June 2019, there are 2450 signatories representing over $80 trillion in AUM.
Figure 1
ESG spiked in popularity between 2021 - 2023, with a downward trend thereafter. However, “Sustainability” has always an average rating of 62 in Google Trends Popularity, compared to “ESG”’s rating of 30. From Google Trends, it looks like that this word is just a fad. The recent surge in ESG initiatives in corporate headlines has been criticized by the media and the Republican party for “greenwashing” or in other words, making purported statements about how beneficial the green initiatives are to the environment.
New Backlash, New Words, New Measurements
Larry Fink, CEO of Blackrock, has famously tried to avoid criticism by switching ESG from his vocabulary to “transitioning.” I found this echoed by Anjali Mahadevia, the head of business development at Future. Future is a series A startup that empowers everyday consumers to transition to green initiatives through monetary carbon credits. Mahadevia often turned to terms like, “green behavior,” “sustainability,” “transition,” and “evolve the definition of good.” The term “ESG” was never brought up until I explicitly asked about both Future and Mahadevia’s personal relationship with the word. Future has no problem partnering with ESG businesses. “Corporate intervention is one of the strongest levers to combat climate change,” says Mahadevia, “but ESG should not be exploited. You can’t manage what you can’t measure, so it’s a start, but not the full picture.”
I interviewed a student who has worked in both start-ups and a specialty finance company. The student's experience on both sides of startup and investor has helped them understand the nuances of impact metrics (e.g., PRI, GIIN, IRIS, etc.). Unlike ESG metrics, these metrics are used to measure the tangible impact of the firm on the environment while making financial returns. For example, an oil company might have higher ESG ratings (e.g., Sustainalytics, Reprisk, MSCI, etc.), but they could have a lower impact on the environment. This is largely due to the encompassing term of ESG, which covers the environment, sustainability, and governance. ESG was so broad that for many years, until the UN enlisted major accounting firms to develop a stronger standard, metrics that couldn’t be measured under financial statements were categorized under “ESG.” Even now that the standard has been set, concerns have arisen about these accounting firms prioritizing client relationships and generating consulting fees over rigorous scrutiny and accountability. "I wouldn’t want to work at a startup with ESG as one of its main pillars," the student explains. Due to these concerns with ESG, the student describes impact investing as an alternative solution. While still lacking strong standardization between industries, impact investing is more focused on developing outcomes that are both beneficial for the environment and financially profitable. This is unlike ESG, which can create a potentially false narrative that leads us to believe something is more “green” than it actually is.
To ESG or not to ESG?
However, this isn’t all to say that ESG doesn’t have a place in the financial world. Quite the opposite actually. When it comes to investing in venture capital, it comes down to finding the right founder. When interviewed by the Harvard Business Review, Brian Jacobs, a co-founder of Emergence Capital, explains: “I have never seen a venture success for which one person deserves all the credit. The winners always seem to be the founders who can build a kick-ass team.” ESG as an internal framework that writes a mission and narrative helps develop the kick-ass founder Mr. Jacobs and other venture capitalists are searching for.
Figure 2
Looking at it from the public markets perspective, most ESG funds have been reported to consistently beat the market. The ESG companies in the S&P 500 between 2021 and 2024 have slightly outperformed the S&P 500. The Vanguard FTSE Social Index Fund was reported to beat 96% of peer funds for the year. Similarly, the Dow Jones Sustainability World Index had a total return of 21.7% in 2023, compared to the average market return of 10%. So while there’s negative media coverage surrounding ESG, the truth is that ESG investing is more financially viable than investing in the market.
As climate technology matures, there’s a new transition trend from venture into investment banking and the public market. Ligia Deschamps, an Associate at JPMorgan’s Center for Carbon Transition, is one of the people spearheading the carbon transition from private to public. Ms. Deschamps notes that while ESG investing has been less popular, it is not entirely due to the backlash, but rather relative to the raised interest rates. In fact, while there’s been a shift away from the word ESG, Ms. Deschamps strongly believes that the negative media surrounding the word has not harmed or even slowed down the net-zero emission goals. However, when asked about sourcing startups to IPO, Ms. Deschamps explained that the process is more thorough and reserved. She accounts this to climate tech still being in the early stages which makes the winners unpredictable. This slower and methodical process highlights the thematic steps when encountering ESG.
The Fable of ESG
The word cannot be slapped on as just a label anymore. The backlash of ESG seems to be successful in addressing the concerns of greenwashing. The trend of ESG has simmered and what’s left of it are new trends that successfully address the criticisms. The carbon transition is one of the biggest developments in human history, one that will take decades if not centuries of effort; and right now we’re still in its infancy. The rise in impact and ESG metrics signifies a shift towards sustainability-focused decision-making, with businesses increasingly using data-driven insights to guide their strategies and investments. This trend is driving greater funding into ESG businesses, enabling them to innovate and scale their operations. As a result, consumers may benefit from more affordable and accessible sustainable products and services. Additionally, the growing demand for ESG expertise is expected to fuel expansion in consulting services tailored to help companies navigate sustainability challenges. These developments underscore the growing importance of ESG considerations in shaping business practices, investment decisions, and consumer choices, ultimately contributing to a more sustainable future.