“Look under the hood”: The difference between ESG and sustainable investing 

Estimates say that we would need to invest $3.5 trillion a year from now to decarbonize all the sectors of our economy in order to reach net zero by 2050. 

While the government is looking to do its part in this transition, passing a $430 billion bill that will help the country reduce its carbon emissions, the private sector also plays an active and important role given its unique ability to invest and innovate.

In finance, the sustainability agenda has now been condensed into three letters – ESG – standing for environmental, social and governance factors that can be embedded into business decisions. 

But the rising popularity of ESG investments in an unregulated market has also attracted quite a few bad apples, leaving investors overwhelmed with the rising number of options, many of which might not even be as “green” as their label suggests. 

Despite being painted as something novel, this type of investing has been around for decades, it just had different names in the past, such as “corporate social responsibility”or “socially responsible investing”. 

Just 10 years ago, there were about 100 different mutual funds and ETFs at Morningstar labeled as “socially responsible investing,” according to Peter Krull, CEO of Earth Equity Advisors. Now, the category is called sustainable and responsible investing, and as of last quarter, there's 557 options to choose from. 

“I can tell you that of those 557 funds, there's a good portion that are greenwashed. Simply taking the time to look under the hood and see what you own is probably the most important thing you can do,” Krull advised.

ESG is simply a set of metrics, a way to gauge a company, no different than analysts do with other financial fundamentals, such as price-to-earnings ratio and book value. The intention, ultimately, is to assist in the research process and help determine what risks are associated with a particular company, Krull said. 

“ESG isn't woke investing, it's just simply enhanced due diligence investing. It's actually putting more time and effort into understanding a company beyond just the numbers,” Krull said at Tearsheet’s Banking on the Planet conference. 

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Source: Deloitte

However, most of the ESG investing that happens today is clouded by greenwashing. New analysis revealed that $1 trillion in ESG funds rated by Morningstar weren’t actually aligned with the values of ESG – 20% of the funds had their ESG stamp removed, feeding concerns that asset managers are making misleading sustainability claims about their products.

Companies like BlackRock simply use ESG metrics to put together indexes, marking them as sustainable when the reality is that they're just simply less bad versions of the underlying index. There's not really anything sustainable or positive about them, Krull argued. 

Meanwhile, sustainable investing is about intentionality and including companies that are making a positive difference in the world, such as addressing systemic risks like climate change, inequality or resource scarcity. 

“An ESG index that reduces its exposure to ExxonMobil is less bad; a portfolio that eliminates it entirely is better, but one that replaces it with First Solar, or another renewable energy company, is actually sustainable,” Krull said.

It’s all about investing in the next economy, thinking about the kinds of industries and companies that are going to be leaders in the transition towards a net zero future, contributing to both increasing resilience and reducing risks. 

This means having a longer-term investment horizon, according to Elizabeth Lewis, managing director and deputy head of ESG at Blackstone. The private equity firm has already invested $16 billion in the energy transition, and believes it has the potential to invest up to $100 billion over the next decade. 

“Short termism is really the enemy of ESG. If you're thinking month to month, or quarter to quarter, you really can't do ESG very well,” Lewis told the audience at the Banking on the Planet conference. 

We’ve come a long way

A sustainability portfolio can include investments in many sectors across the economy, with the most popular being real estate (green building technologies), sustainable agriculture, and electric batteries. 

If 10-15 years ago it was pretty easy to get a good grasp on all the different trends related to sustainability, today it’s easy to feel overwhelmed by the number of options. 

“It's hard to feel like you can know everything in today's day and age. It's a difficult problem, but it's also a good problem, because it means that these sectors have really grown a lot,” she said.

As an investor, it’s difficult to have expertise on all of these different types of technologies and sectors, especially given the fast rate of change and innovation currently taking place. 

“You want to feel like you're an expert in a sector before you even start to understand the fundamentals of a particular business. I think that’s one of the most challenging parts – just making sure that we all stay educated in these areas, but we've come a long way,” Lewis said.