The Green Finance Podcast Ep. 9: Unpacking the politicized world of ESG with Peter Krull, CEO of Earth Equity Advisors

I've got a great episode for you today, starring special guest Peter Krull, CEO of Earth Equity Advisors. I always love talking to Peter about all things climate change, especially ESG. I feel like he's got a really healthy way of looking at it, because there's a lot of hype in this sector. So don't believe the hype, and always look under the hood.

Peter spoke at our Banking on the Planet conference this past July on a similar topic, and I highly encourage you to check out that interview if you're interested in learning more about the ins and outs of sustainable investing.

On today's podcast, Peter and I are again talking about how to think about ESG, but this time with a sprinkle of politics – we've seen that a number of states have started to ban financial institutions that sought to distance themselves from fossil fuel industries, so the drama in this sector shows no signs of slowing down.

All of that and more, in today's show, so let's dive right in.

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The following excerpts have been edited for clarity.

ESG funds attracted more than $1 trillion over the past few years. What's been driving ESG into the mainstream so much?

Peter Krull: Well, I think if we go back to 2020, people had a lot of time on their hands. In terms of new assets, 2020 was a great year for us. I think one of the reasons is people were getting their statements, and they were actually opening them up. I mean, I can't tell you how many times we've had new clients come in, and they've got like six months of statements that are still sealed, they've never actually opened them up. So I think in 2020 people were actually opening them up and looking at them and seeing either A – that they had things like Exxon and fossil fuels and different things that really didn't align with who they were, or B – they saw a lot of different mutual funds and things that were in their portfolios that they had no idea what they were, and they wanted to understand that more. I think that partly drove the demand we're seeing. 

We're also seeing demand come on the institutional side, but it's a different kind of demand. Retail investors and institutional investors call for two different things. Retail investors, based on the clients that we have, and the people that I talk to on a regular basis, they want to see investments that are positive, they want to see some intentionality to the underlying assets in any fund, ETF or just an individual stock portfolio they have. They want to see that there's a direct link between what they own, and something that's going to make change in the world, be it climate change related, environmental, social, etc. Whereas on the institutional side, it's more generic – they simply want to know that there is some sort of ESG screen that has been placed over the universe of stocks that are eligible to be in their particular fund. And what we've seen more often than not, is that the institutions focus more on the G or the governance side, which I would argue, is something that they should be doing anyways, outside of any ESG paradigm. 

We're not really seeing much in terms of impact on the institutional side, and I think that's where we start to run into the whole greenwashing topic, which is a huge one. How can we possibly have 50% of assets worldwide considered ESG? Well, the reality is, you can't, and I broke this down for you when we did the Banking on the Planet, but I'll break it down again – ESG is a tool. It's a set of metrics, it's basically numbers, but what we find is that a lot of the big institutional investors like the ones I was just talking about, but also the big retail providers, the Blackrocks of the world, are basically just taking that data, overlaying it on the S&P 500 or MSCI, or whatever particular index that they want to use, and calling it sustainable. Well, it's not really sustainable, it's basically just a less bad version of the underlying index. So the example I like to give is, you've got an ESG index that reduces its exposure to Exxon, it just simply makes it less bad, right? If you eliminate ExxonMobil entirely, it makes it better. But if you replace it with something that's actually positive, like, say, a First Solar or something like that, then it's actually sustainable. But ESG and sustainability are not equivalent to one another.

An increasing number of technology providers are looking to enter this market to increase transparency, to pull data together, to create ratings around all these financial products. What do you think about this industry? Will more standardization come from innovation and technology, or do we need government intervention here?

Peter Krull: I think we need all of the above because we've got a number of rating agencies, like MSCI, Sustainalytics, those are two of the biggest, where most of the institutions are sourcing their data from. The problem is, when you look at MSCI ratings, and when you look at Sustainalytics ratings, they can be completely completely different. So how can you tell which one is right? Is either one of them right? And how do you know going forward? How do you have any sense of certainty? Certainty is not the right word, we're never gonna have certainty in this. But how do you have any sense of comfortability that the metrics that you're using are kosher, that they're actually something that is related to the underlying security?

We do have to have some form of government intervention where there is a standard set for disclosure, and there has to be some accountability related to that disclosure. In that way, everybody's getting the same data, you can use different algorithms based on how you want to rank things. Right now, it's pretty much just a guessing game, which one you feel is better versus another one. And so when we put together our individual stock sustainability portfolios, we're using some of that data, we actually pull data from Sustainalytics. But we're also just simply looking at the industries that we feel will lead us forward. We're not even starting out from a universe that includes everything, we're starting out from a universe that already says that we see what the next economy needs – we know that we need clean energy, we know that we need energy efficiency, we know that water is going to be a huge problem. 

When you look at a traditional index, that index is based on where the economy was yesterday, it's sort of like investing by looking in the rearview mirror. We would much rather invest looking forward. So while we use ESG data to help us pick between the companies that we feel are best, we're also not trying to please everybody at the same time. Part of what we run into is that institutions are focused on tracking errors – how does your investment perform relative to the underlying benchmark? We need to get away from the concept of tracking error, because tracking error is benchmarking based on the old economy, whereas we need to be basing our performance on where the markets are going. And you can't necessarily do that by looking back and seeing where the S&P 500 is, it just doesn't make sense anymore. I mean, the world has agreed that we have to be carbon neutral by 2050. I think ultimately, that's too late. We need to be carbon neutral quicker than that. So what are the companies and what are the industries and sectors that are going to get us to carbon neutral, as fast as possible? And what are the ones that are also going to help us be resilient in the face of these storms that are gonna get worse and worse?

What do you think is going on behind the politicization of ESG considering the recent Republican backlash against financial institutions?

Peter Krull: Well, there's a lot of things going on here. I'll start out by saying that a lot of it is just simply a dog whistle, if you will, to these particular politicians' base – anything that they can do to rile people up, they're going to do it, whether it's critical race theory or ESG. They're going to do something that pits us against them, because that's the way they practice politics. But underlying it is a sense that these states are not preparing for the next economy. They don't want things to change. You know, West Virginia has coal. Texas has oil, Florida has tourists. They want to protect the industries that they have, and that's completely understandable. But at the same time, they're doing a serious disservice to their residents by not thinking about where they're going, by maintaining the stance that well, we're going to continue to dig up coal, or we're going to continue to extract oil. 

It's sort of the same idea of we've got these cell phones now that do pretty much everything, nobody is using a dial phone anymore. It's sort of this concept that we've moved past and it's time to move forward. They're really stuck clawing to what they had, and that's sort of a thing that we do here in the States, right? We like the way things were, we're not necessarily looking ahead. And so these politicians are taking advantage of that. 

Utah got upset that S&P rated their bonds, I believe it was moderately negative for environmental reasons, which was drought. The West has severe drought, and it's going to continue to have severe drought going forward because of climate change. The weather patterns are changing, the water cycle is changing out there, and it is a material fact that drought is going to negatively impact the economy. If they're dropping their ratings because of drought, it's something that I want to know as an investor. They are upset about it and say, well, you shouldn't be punishing us because of that. It's not punishment, it's the reality that you haven't planned for an economy that is going to be water-sensitive. If you start to actually take remedial action, if you actually start to look forward and figure out ways that you can reduce your water usage, that you can actually be more efficient, then maybe that gets fixed, but it is a material issue. 

What's ironic about the whole thing is that BlackRock is probably the largest fossil fuel investor in the world. And yet they're the ones that get banned. And believe me, I do not love BlackRock by any stretch of the imagination, but kicking them out of investing pension funds in Texas and Florida and West Virginia, it just makes absolutely no sense.