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Going beyond the ‘G’ in ESG in a world of climate breakdown. Earth Day 2022

Environmental, Societal and Governance (ESG) considerations have been a feature of the investment landscape for a number of years.

A lush green forest

The EU’s Sustainable Finance Disclosure Regulation (SFDR) has categorized those investment funds that have a non-financial objective such as environmental or societal aims, in addition to their usual investment remit, and prompted a raft of funds to make a conversion to become designated as Article 8 (“light green”) or Article 9 (“dark green”) products. 

Of these, Article 8 is the dominant category, with only a small proportion of investment products having dark green Article 9 status. 'Dark green' Article 9 portfolios are invested in shares of companies that are devoted to environmental clean-up, social housing, renewable energy provision and other topics that focus on the ‘E’ and the ‘S’ of ESG investing.

However, if you look across the majority of investment products available from the mutual fund industry, the emphasis is very heavily weighted towards focusing on the ‘G’. In other words, this means analysing companies and engaging with them on governance matters. While this is still very much both necessary and laudable, governance issues within portfolio companies are about how well a firm is run as a business. In much larger corporates, governance can be exemplary, but may not necessarily offer investors much in the way of positive environmental or social considerations. 

For investors concerned about climate change, environmental degradation and a better society, the small number of Article 9 funds offer one solution for their capital. However, another avenue for investors lies in venture capital (VC), which invests in smaller firms and start-ups that are working on products and services in innovative sectors. They are often focused on technologies and approaches that can directly or indirectly help to solve environmental and societal problems. VC portfolio companies are of course still seeking to provide attractive levels of return as viable businesses, and those that have either an environmental or societal approach are seeking to do well by doing good. 

VC as a sector is, perhaps surprisingly to investors more used to the mainstream investment industry, already heavily focused on ESG. In the US, around one in 10 VC companies has an explicit ESG remit, and up to three-quarters will have at least an implicit ESG approach. This is vastly more favourable than the narrow set of mainstream investment funds that have an Article 9 dark green classification, estimated to be less than 4% of total fund assets under management – and this despite strong investor interest, particularly in Europe. 

The statistics alone should prompt investors looking to achieve positive environmental or societal results with their capital to consider VC as an investment avenue. 

And, within this sector, there is the potential for investors’ capital to be put to work to help scale up innovative solutions that may not be on offer from Article 9 funds that are largely investing in publicly- listed companies.

Just look at a small company like Ananas Anam, who are behind Piñatex, and are producing leather-like fabrics from pineapple leaf fibre for use by fashion giants such as like H&M, Hugo Boss, and Paul Smith. The pineapple farmers get a fee for their pineapple leaves that would otherwise go to waste after the fruit is harvested. And the world gets an innovative leather alternative. 

These kinds of creative, innovative success stories are more likely to be found in the realm of VC than in an established, listed company. Of course, both have their place in a diversified portfolio. Today’s investors have options available to them like never before, and by looking a little further afield than the traditional options, they really can do well by doing good for the world.

Written by Dr Lisa Smith, Managing Director

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