Council Post: The Fifth Dimension Of ESG Investing

Chairman and CEO, Transformation, LLC.

There is a rising tide of enthusiasm and capital for environmental, social and governance (ESG) investing. However, the good news about ESG is also the bad news: The concepts are broad enough to be subjectively interpreted to include almost anything, and many companies succumb to the temptation to hide the ordinary under the green banner for a variety of reasons. This phenomenon is called “greenwashing.”

One way to define, visualize and measure ESG is by industry. When doing so, you see energy, water, agriculture and healthcare: the four visible dimensions of impact. Indeed, it’s becoming clearer that measuring impact and insisting on impact are the best ways to accomplish ESG objectives. With impact investing, you can see the visible change: A solar plant replaces a vacant sandy desert. Yet privately directed impact investing represents a small percentage of ESG investing. In a recent Institutional Investor article on ESG, the authors discuss their review of 431 private equity firms that report to Principles for Responsible Investment. They found that roughly 12% of private equity firms publicly disclosed ESG reports from portfolio companies.

Now, there is a fifth dimension of ESG: technology, such as artificial intelligence and deep learning algorithms. The true meaning and promise of the fifth dimension are the transformation of all four dimensions to achieve radical efficiency, faster results and quantum impact.

The Institutional Investor article highlights that although ESG investing is on the rise by private equity firms and has good intentions, there are still many issues with the approach and reporting surrounding ESG. The authors state, when talking about the case for ESG that, “our research indicates that rhetoric is ahead of reality and that the focus on process far exceeds the delivery of progress.” 

The article comes at a time when a focus on the environment and global public health and safety has never been more important. So, shouldn’t the rise of ESG be good news? 

Speaking as one of the few who have been working in the impact investing space since the early 1980s, I have learned that there are multiple dimensions and complexities to the challenges, and also multidimensional layers to the solutions. The human psyche appears to respond more decisively to immediate crises like Covid-19 than to long-term, slowly building conditions that are leading to even greater catastrophes, such as pollution and climate change.

However, we are starting to understand that the causes of pollution and climate change have accelerated the global transmission of zoonotic diseases like Covid-19. Although we are still learning much about this particular virus, the World Health Organization has warned that “changes in infectious disease transmission patterns are a likely major consequence of climate change.” The United Nations has recently also stated that to prevent the next pandemic, environmental health and protection are key. These three problems are all intertwined and have a lot more to do with one another than most people think. 

Now is the time to make ESG directly relevant to the world’s most serious challenges. It is not an intellectual game about picking stocks and bonds that look “green.” This is about investing in companies that improve the human condition in visible and important ways. This is about achieving real impact in the most profound way. Results are everything.

If private equity firms are going to make real impact through smart, targeted investments, their approach needs to change. Investors should focus more capital on direct impact investments and less on applying ESG screens. Choosing or not choosing investments because of their environmental, social and governance metrics and criteria (or lack thereof) is good in theory, but it doesn’t do enough. ESG screens alone will not have the direct, powerful impact necessary to reverse the current pace of pollution and climate change, not to mention the current biggest issue: the pandemic. ESG criteria, even if applied correctly, will have too slow and indirect an effect on how the world actually works. The reversal will occur too late.

However, today we are blessed with technology that can make our impact larger and more efficient — more impact with less input. Advances in artificial intelligence, energy storage, electric vehicles, waste to energy and carbon capture are just some examples where scientists and engineers are making changes that will have huge downstream effects on waste and emissions reductions and system efficiencies across industries. The challenge for private equity investors is identifying and practicing due diligence on these companies. They can improve this process by bringing on advisors and experts who have been in the sustainability space. 

From my experience, firms typically resist impact investing because it is challenging, specific, directed and visible, and people can measure whether you’re doing it or not. Real impact requires real work.

European countries have been much more successful at interpreting ESG in a manner to achieve impact. In the first half of 2020, clean energy powered 40% of Europe’s electricity. This was a combined concentrated work effort of the government and the nation’s thought leaders. ESG was the original inspiration, but impact was the ultimate goal and the end result. 

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