Defining The Next Generation Of ESG Investing

The last few years have accelerated the conversation for many investors around the importance of integrating environmental, social, and governance (ESG) factors into their investment analysis to drive returns. ESG investing as we know it began in the 1960s, fueled by the civil rights, antiwar, and environmental movements. It was originally coined as “socially responsible investing” and manifested in strategies like the boycott of companies who provided weapons used in the war, avoiding “sin” stocks that dealt in alcohol, tobacco, or gambling, and targeted investments into housing projects.

Today, after decades of protests, political progress, and legislation, ESG investing is mainstream. Over 33% of all assets under professional management in the US are now put into socially responsible investments, and a record $120 billion was invested in ESG-focused ETFs in 2021 (more than double 2020s $51 billion). We’re seeing dramatic growth on the retail side as well, with money managers reporting a 50% increase between 2018–20 in the amount of sustainably-invested assets they manage on behalf of retail and high net worth investors. And these investments are outperforming and showing lower volatility — 77% of portfolios with ESG have survived the last 10 years, versus 46% of others.

It’s clear that the importance of environmental, social, and governance issues are no longer just the prerogative of the socially conscious, but those seeking top financial returns as well. Regulatory tailwinds, environmentally-friendly legislation, and mandates that reduce socioeconomic inequality will continue to create more opportunities for big gains for these companies in the coming years.

As part of an effort to grasp social and environmental trends in the context of digital transformation and consumer behavior changes over the last two years, Sam Giber, a Partner at investment fund Blisce (founded in 2014 by entrepreneur Alexandre Mars) recently published a report titled 2022:The Reopening Outlook. Sam has helped lead the firm’s investments in high-growth companies utilizing technology to drive social and environmental impact including Headspace Health, Redesign Health, Imperfect Foods, and Empower.

The report analyzes consumption data, web traffic, industry research reports, and data from Blisce’s portfolio companies, as well as a proprietary survey of over 450 European and US consumers, focused on categories such as, online fitness, telehealth, food delivery, online shopping, online education, video games, and social media.

I asked Sam to dive into the report with us, give us his thoughts on the ESG landscape, how the pandemic evolved consumer behaviors, and what the future of sustainable investing looks like.

Heather Hartnett: How are you seeing startups building and innovating around sustainability?

Sam Giber: There is a lot of work to be done and we are seeing founders rise to the challenge. Right now, we are seeing the most activity in three key areas: food, materials, and energy.

New players are fighting food waste and making both food supply chains and production more sustainable. Most recently, we invested in Too Good To Go, which is connecting 50 million people with over 140,000 markets and restaurants to reduce food waste, saving 121 million meals this year. Similarly, we invested last year in Imperfect Foods which has saved over 150 million pounds of food since its inception.

In food production, we have a range of new plant-based foods and cellular agricultural startup companies coming to market. Wildtype just raised $100 million to use cellular agriculture to grow sushi-grade salmon in a lab. I’ve tasted it and couldn’t tell the difference. We also have companies like Wild Earth making plant-based dog food. If all the dogs and cats in the US made up their own country, it would be the fifth-largest country on the planet in terms of meat consumption.

In materials, we’re seeing companies figure out how to make fabrics and leather without animals and with minimal environmental impact. Modern Meadow and Bolt Threads are using fermentation and protein engineering to create bio fabricated materials that deliver on quality while reducing emissions substantially. There are also new companies creating carbon-neutral or even negative processes to create cement and industrial metals such as Brimstone.

In energy, we’re seeing the transformation of grid management, the proliferation of EVs, and the rise of the carbon offsets market, alongside potential breakthrough technologies like nuclear fusion. It’s still seemingly far from commercialization but fusion has the potential to power a home for a year with the energy stored in a glass of water. Zap Energy and Commonwealth Fusion Systems in Boston (which just raised $1.5 billion and is attracting top engineers from Tesla and SpaceX) are two players in that space. We’re also seeing a lot of new software start-ups helping consumers, companies, and investors better measure, manage, and offset energy use and emissions –– examples would be David Energy and OhmConnect for buildings, Wren for carbon offsetting, Bonnet in the EV space, and Arcadia for clean energy. Carbon management software such as Sylvera, Watershed, Reforest Action, Pachama, and Plan A is also driving attention to the need for measuring and monitoring impact; we actually use Plan A for our own fund.

The fact is we need more of all of this, and we’re seeing a groundswell of capital, founders, talent, and LPs finally rising to this long-overdue challenge.

Hartnett: You recently released new research on the “reopening”. What are you seeing in how sustainability is driving consumers?

Giber: Last spring, we began conducting research on how consumer trends were changing around the reopening. We looked at data from our own portfolio and conducted surveys of consumers across the US and EU. Sustainability and the growing demand for sustainable e-commerce, brands, and products were among the key consumer trends in the report.

After the pandemic, we observed consumers across the board expecting companies to do more. Of those we surveyed, 54% felt more strongly than they did pre-pandemic about what a company does and should do to protect their employees and give back to their community. Another study from Boston Consulting Group showed that 75% of consumers think environmental issues are as concerning or more concerning than health issues after the pandemic. Sustainability initiatives are also a major driver of growth, with sustainable consumer products growing 3–5x faster than other segments.

While consumers care more and more about sustainability, our data shows price and quality remain key drivers as well. What we’ve seen and analyzed from the companies in our portfolio is that there are a few different segments of consumers when it comes to sustainability in consumer brands.

First, we have climate warriors who pride themselves on buying sustainably. These consumers are extremely loyal, evidenced by strong retention and repurchase rates, but they leave very quickly if a brand is shown to be inauthentic when it comes to its sustainability and impact. We’ve seen 50% drops in customer retention for companies that drift from their mission. Next, we have consumers who are shopping on price, quality, convenience, and aesthetics, but will always take the sustainable option, the price being equal. And then we have consumers who are not actively prioritizing sustainability as a top factor in their purchases. These are the hardest consumers to impress, but they are crucial to scalability.

The reality is that to win in the mass market and really scale, sustainable consumer brands and technology companies can’t just be more sustainable today. They also must either achieve cost parity, be better quality, or make things faster and simpler.

Hartnett: What’s driving companies to get serious about sustainability and its impact?

Giber: We are living through this moment of urgency. The confluence of increasing government regulation, consumer pressure, tight labor markets, environmentally-driven volatility of supply chains and material costs, and shifting employee preferences are driving companies and their investors to focus on environmental and social causes.

Leaders and their teams are stepping up authentically to recognize climate change as a defining issue of our time. They are taking active measures to mitigate climate risk and reduce emissions. There is a genuine concern that exists and many companies are taking action. Just earlier this month, Stripe and Alphabet announced a $1 billion fund for carbon removal.

We see increasing pressure from regulators, citizens, the environment, and consumers, which is driving these decisions. At the same time, lower capital expenditures on fossil-fuel-intensive sources of energy and materials are driving rising input costs. This is shining a spotlight on the growing costs of using carbon-intensive materials, and the challenges of disparate global supply chains at a time of increasing environmental volatility. We also see many executives, engineers, and talent wanting to make an impact on climate change.

Millennials and Gen Z are especially big players in this push. We see them utilizing the power of social media to hold brands accountable. In May and June of 2021, we saw viral TikTok content about “Rainbow Capitalism,” where young people were criticizing brands for what they saw as an attempt to cash in on Pride Month when the businesses themselves were not authentic in supporting LGBTQ+ rights. And this extends beyond making a 30-second video. Gen Z has massive spending power –– and they’re spending it on companies that care. According to a 2020 report by First Insight, 73% of Gen Z consumers surveyed were willing to pay more for sustainable products, more than every other generation. Not to mention this generation makes up the workforce of today and tomorrow and will continue to prioritize companies with an authentic impactful mission.

Hartnett: What is happening in the market for investors today on ESG?

Giber: Over $640 billion flowed into ESG funds in 2021, up from $280 billion in 2019. In terms of venture capital, Climate Tech VC estimated in 2021 that VCs invested about $40B across 600 startups and saw the rise of 70 new climate-focused VC firms. Of the $40 billion, 90% was invested in food, water, energy, and mobility. In Q4 of 2021, five times the number of climate startups were funded at the same time last year. There is so much happening so quickly in this space –– in part because we are running out of time, and in part because of consumer and social pressure. But regardless, it’s happening, and it’s happening fast. And investors want a piece of the action because it’s an opportunity both for returns and for impact.

What’s changing is the demand for authenticity, measurement, and transparency. LPs and allocators that are investing in these funds labeled as ESG are asking to see evidence that the funds are truly taking environmental, social, and governance impact seriously. In turn, the investors are increasingly doing the same for the companies that they invest in. For companies and investors that are authentically taking consideration and action on climate change and other important issues, it’s an opportunity to stand out.

We’re also seeing growing regulatory action. Recently, Gary Gensler, Chairman of the SEC, posted a video on Twitter where he called out 800 funds representing over $3 trillion of assets that are labeled as ESG and asked them “what information supported those claims.” The EU is currently working on a framework to regulate claims of ESG with the rollout of SFDR (Sustainable Finance Disclosure Regulation). I’m intrigued to see if the US does something similar. We expect to see the SEC mandate disclosure of carbon and environmental emissions as well.

Hartnett: What does this mean for companies looking to attract ESG capital? How are you advising portfolio companies on ESG?

Giber: One of the hardest things for companies to do, and one of the most common traits of our most successful companies, is to focus. The challenge we see every day is founders, boards, and management teams are looking at this alphabet soup of ESG, B-Corp, GRI, SASB, SFDR, SPO, etc. and saying “we want to take action,” but then asking themselves where to start and what really matters.

Companies can’t have two or three missions. Boards and leadership teams have to ask themselves: what is most material in terms of environmental and social impact to our strategy?

You have to define an ESG strategy that is authentic to your business, connected to your core product, and that is going to accelerate your business and make your company more resilient. That’s how you get your future customers, team, and investors to value this work.