ESG scores aren’t enough

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Emily Chasan's Good Business

Just like in traditional investing, there are dozens of strategies you can use to be an ESG investor. There are funds that pick the best-rated low-carbon companies, funds that focus on companies with more women on boards, and funds that use a series of ratings and checklists to ensure the stocks they are betting on are "better" than the rest of the market.

But is that the best way to get to a more sustainable future? The confusion over what ESG strategies actually do has been a hot topic this year for the mutual fund industry, the U.S. Securities and Exchange Commission and even the Department of Labor. Part of the issue is that investing to match your values is actually pretty different from methodically picking out the companies best able to survive in a sustainable, climate-aligned future. 

Generation Investment Management, the $24 billion asset manager started by former U.S. Vice President Al Gore, released a guide last week for how investors can systemically map the future. The key is to ask what societal shifts need to happen to make a company's sector truly sustainable, whether it will benefit from that transition, and whether its leaders are long-term thinkers with the levers, coalitions and partnerships to make change happen. In other words, it's less about now and more about later.

"We believe the very best companies can see around corners," said Lila Preston, co-head of Growth Equity at the London-based firm. "The benefit of using a roadmap is to see the long-term horizon and figure out if the company is going to really enable us to transition to a zero, net carbon, prosperous, healthy and safe economy." 

Generation has built hundreds of these predictive roadmaps for different industries. This strategy, for example, led it to start betting on companies that enable more remote work back in 2016 and to buy a stake in a microbe-based alternative protein company this year. As an investor, having a clear vision of the future helps one decide what trends will catalyze, accelerate or impede a company's results, according to Preston. "The biggest companies are not going to arrive overnight, but what we're looking for is alignment on the direction of travel: we're really looking for those moments where the system shifts."

Investors are increasingly asking companies to do climate scenario planning and measure their own futures against a warming world, but it's still rather uncommon for those same investors to base their own portfolios on a similar exercise in prognostication. Instead, current ESG ratings and exclusionary strategies tend to dominate socially responsible and sustainable investment portfolios these days.

"It's so rare to do all this forecasting and scenario planning about the future," said Garvin Jabusch, chief investment officer of Green Alpha Advisors. The Colorado investment manager bases its strategy on what it sees as a highly efficient, sustainable next economy, which has led it to bet on renewable energy and electric vehicle companies like Tesla. But there are few companies available to buy on the public stock market today that investors can be sure have the right strategies to survive the eventual transition to a net zero world.

"The science tells us we need to stabilize the climate crisis in 35 years, and to do that we need to be improving the situation by about 2% every year," Jabusch said. "Most companies are just not contributing on that level yet, regardless of what their ESG score says."

Sustainable Finance In Brief

Emily Chasan writes the Good Business newsletter about climate-conscious investors and the frontiers of sustainability.

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