“ESG investing is the biggest economic opportunity of the 21st century, we just need to do it in a very different way. If you want to change the world, if you want to support an ESG-focused agenda, if you want to help with the problems we’re facing with climate change, and if you want to make a lot of money, what you need to do is invest in early-stage startups which are focused on these kinds of problems. And you need to invest in a lot of them.”
At #LEAP22, Maëlle Gavet (CEO at Techstars) started with a cautionary tale. It was the story of how, between 2006 and 2011, venture capital firms in the US invested more than USD $35 billion into clean energy.
They were spurred on by the likes of Al Gore, with his hard-hitting climate change documentary An Inconvenient Truthand by respected venture capital players including John Doerr, who said that green technologies could be “the biggest economic opportunity of the 21st century.”
But following that enthusiastic investment phase, the VC industry lost more than $13 billion.
There were, of course, a number of factors at play. Bad timing, perhaps. Or venture just wasn’t the right model, with such a long time period to wait before investors would hit profitability. But today, although the economic and social landscape is far better prepared for investors to make a good ROI on green tech, Gavet thinks the way we’re investing in environmental, social and governance (ESG) companies is all wrong.
To make money from green tech, and to actually make the world a better place, investors need to shift their focus completely.
What’s the problem with ESG investments?
According to research by PwC, private investors put $87.5 billion into climate tech between July 2020 and July 2021, and the average deal size more than quadrupled in that 12 month period. Back in 2014, the World Bank estimated that the climate tech opportunity would be worth USD $6.4 trillion over the decade ending in 2021.
A huge opportunity, then. So what’s going wrong?
Why are investors not getting reliably superior returns when compared with conventional investments? And why are ESG investments not making a significant impact when it comes to climate change (or at least, not making an impact very quickly)?
Critics of ESG investments talk about a plethora of potential problems. Writing for QUARTZ, climate reporter Tim McDonnell suggested that the ESG scores underlying investment portfolios are often based on misleading interpretations of data, more interested in how a company will be affected by climate change than how climate change will be affected by the company (as revealed in an investigation by Bloomberg).
At LEAP22, Gavet noted that many of the investments listed under the ESG banner actually have “little or nothing to do with ESG at all.” Instead, ESG investments are advertised because companies know that ESG is a selling point — but it’s just “shameless greenwashing,” to make companies and investors feel good about what they’re doing.
When it comes to returns performance, the reason ESG investing doesn’t reliably outperform conventional investing is probably because when investors choose an ESG company, they’re not actually investing in…an ESG company. Research by index provider Scientific Beta found that in the US, 75% of ESG outperformance was due to factors that had nothing to do with ESG.
“They perform in line with the market because they are the market — basically the same companies, but packaged up in different ways and in new indexes,” Gavet explained.
Entrepreneurs are the solution
Current fixes underway in the ESG market include changes to how ESG is defined and categorised — to make the parameters clearer, and make it harder for companies to claim ESG credentials without solid evidence. Crucially, this requires more transparency around the metrics that are used to produce ESG ratings. The World Economic Forum is working on this by asking major corporations to commit to its common stakeholder capitalist metrics.
For Gavet, however, efforts to improve transparency and mandatory reporting will only ever go so far. Pushback from powerful stakeholders will always slow the process of change — and we don’t have time for green tech development to move slowly.
“If you look at history, in the vast majority of cases, legacy companies changed course only when they had to, not because they wanted to. Because frankly they have very little incentive to disrupt themselves. Sometimes they changed thanks to government entities and to regulators, but more often than not they changed because disruptors were starting to eat their lunch.”
The answer isn’t to keep investing in public corporations for an average market return, because that won’t have any meaningful impact on climate tech and climate change. Instead, the answer is to invest in the private market, and to invest in startups as early as possible. Because “the most dramatic and world-changing ideas…they grow at the earliest stage of startups.”
Right now, more than 3000 climate tech startups are pushing the needle on genuine change. Companies like Accelerate Wind, which is developing affordable wind turbines that enable commercial buildings to harness wind power from the edges of their own roofs; DroneSeed, which is making reforestation scalable using drone-powered seedling distribution; and Phoenix Tailings, the world’s first clean mining management management company.
There’s little doubt that ESG investing is an immense economic opportunity in the 21st century. But as Gavet put it, “we just need to do it in a very different way.”
Investors who want to change the world — and make money at the same time — need to turn their attention away from incumbents with big teams, big limitations, and a slow pace of change. Instead, they need to put their money into fledgling startups with innovative visions for the future, which have ESG built into their DNA. Big corporations will catch up later (when they get hungry). But they’re not going to lead the way.