Green Finance Advisor of Friends of the Earth (HK)
In previous blogs published with the organization, the fact that companies with higher ESG scores have benefitted from cheaper financing and lower risk premium has been pointed out on several occasion. This differentiation was most marked since the 2010s and has continued since throughout the pandemic and in the new higher interest rate environment, especially with the increasing availability of ESG investment vehicles, both passive and active, as well as regulatory and investor adoption of ESG standards as part of the investment process. The encourage results can be seen recapped in the following chart, showing the bottom fourth and fifth quintile of companies ranked by their environmental and social headlines, have underperformed their peers over the past 11 years.
This may be difficult to picture in terms of the impact capital markets has in the need for Green Capex especially when critics argue that green investing should be the responsibility of government. The following chart shows that $0.9tn of the $2.8tn needed in Green Capex is met by the private sector comprising of both public and private companies.
Source: IEA, OECD, McKinsey, FactSet, Preqin, Goldman Sachs Global Investment Research
Thus, the continued application of ESG criteria in investing by both the investor and the regulatory, and the further fine tuning and improvement of current frameworks are making a significant contribution of 32% towards investing in our green future.
However, as we enter 2023 after a difficult year for capital markets in 2022, many investors’ top of mind concern may not be investing in a green future, but rather how to invest in an environment of higher interest rates where deposits pay almost 5% and to avoid risks and drawdowns in a potentially recessionary scenario.
It is at this juncture that we should remind ourselves a few principles. First, green investing was never about short-term returns. Focusing on annual returns would defeat the goal of nurturing loss-making but promising companies with the right technology to tackle climate change. Indeed, even the typical structure of a venture capital fund with its 10-year life would be considered too short for investing in game changing green technologies such as nuclear fusion. We should in fact think of these investments with a timeframe of over 15 years to give these nascent technologies enough time to germinate, a philosophy that is advocated by the Breakthrough Energy Ventures, an investment vehicle backed by some of the most prominent wealthy philanthropists in the world.
Second, even though many of these green related companies may not be profitable in the near term, the market has rewarded growth in the past, take for example Tesla, which has enjoyed some of its best stock performance well before it was a profitable company. This is all the more important in a higher interest rate environment, where the required rate of return is higher for an investor to take on equity risk. For instance, a utility company with dividends of 4% per annum will struggle to attract capital allocation will likely not perform well in this higher interest rate environment as investors can merely allocate capital to risk-free deposits at 5% without having the equity risk of the utility company. On the other hand, a nascent green company that has a promising technology with revenue growing at 15% but yet to be profitable will likely perform better given the future expected revenue growth and the eventual decrease in cost as the technology becomes more mature, is more widely adopted, and as economies of scale increases.
Thus, all in all, despite the apparent headwind of a higher interest rate environment poses to ESG investing, going into 2023 and beyond, investing in companies both public and private with good ESG scores remains one of the most compelling investment theses for investors.
 Singer, B., Bingham, D. R., Tylenda, E., Corbett, B., Jones, E., Wu, M. H., Chinello, E., Meyer, M., Kim, K., Venugopal, V., Chen, G., Aggarwal, R., 10 Predictions for Sustainable Investing in 2023, Goldman Sachs Global International Research