How the Sustainable Investing Trend Is Missing the Boat

Sustainable investing has various definitions depending on who is asked. There is evidence to suggest that there may be a disconnect between the current ESG reporting and innovation for sustainability.

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Sustainable investing has been on a tear since the first green bond was issued by the European Investment Bank in 2007, lately becoming a buzzword in financial markets in recent years. At the end of 2020, sustainable investment accounted for $17.1 trillion (roughly one third) of $51.4 trillion total managed assets in the US (Fig. 1). The global trend is similar and is forecast to continue well into the future (Fig. 2).

Fig.1—The growth of sustainable investing in the US. Source: MarketWatch.
Fig. 2—The growth and forecasted growth of sustainable investing globally. Source: DiversyFund.

Sustainable investing has various definitions depending on who is asked, but BlackRock, currently the largest asset manager in the world, defines it as “a range of strategies that combine traditional investment approaches with environmental, social, and governance (ESG) insights to seek to deliver both financial and purpose-driven outcomes.” At the top of the list of ESG considerations encompassed by sustainable investing are environment-related themes like climate change, global warming, and plastic reduction. Other themes garnering interest include community development, multicultural/gender diversity, and sustainable development goals.

If the raw dollar amount is not convincing enough, surveys of investor sentiment also indicated a growing trend. Survey data from Morgan Stanley show the increase in the number of participants that are “very interested” in sustainability investing to be up from 19% in 2015 to 49% in 2019. Among millennials, the numbers are significantly higher (Fig. 3).

Fig. 3—Interest in sustainable investing jumped in 2019. Source: Morgan Stanley, Institute for Sustainable Investing.
Morgan Stanley

The Breadth of Sustainable Investment Options

Sustainable investing is available to investors in a variety of forms and vehicles. Broadly speaking, they can be sorted into three categories.

Equities. Green equities are perhaps the simplest and most direct method of green investment for an individual or institution. An investor picks a publicly traded company believed to be “green” and purchases some of the company’s shares. This approach has the advantage of being direct and does not leave any question as to who or what an individual’s money supports. It does rest on the assumption that public statements made by the company are accurate. This has generally been a safe assumption due to rules enforced by market regulators, but not a bulletproof one as evidenced by various corporate scandals such as Enron and Theranos.

Mutual Funds/Exchange Traded Funds. Mutual funds and exchange traded funds (ETFs) represent share in the ownership of a portfolio managed by a third party (and investment or portfolio manager). Often created with a theme in mind (such as tracking the S&P 500 or, in this case, investing in green companies) these vehicles offer the private investor a way to outsource much of the research burden that would otherwise be associated with picking individual stocks. The portfolio manager (an individual or team) selects companies in which to invest based on their business prospects as well as whether they align with the stated goal of the fund. Investment funds make it easy to diversify investments at a relatively low cost. However, when it comes to green funds, the lack of existing definitions or regulations surrounding them demand extra vigilance on the part of private investors, requiring research into the fund’s holdings to determine whether they align with its (and the investor’s) stated mission.

Bonds. A bond is a loan made by an investor to a company (or government) at a specified interest rate and maturity date. A green bond differs from a traditional bond primarily in that the capital raised by a green bond must be spent on environmentally friendly projects.

Prospects for Sustainable Investing

The prospects of financial success from pursuing sustainable investment strategies, while not guaranteed, seem probable. In 2020, the S&P Clean Energy Index heartily outperformed the S&P 500 (Fig. 4). This can be attributed to two factors. First, supply and demand—more money chasing a limited asset pool will drive up prices. Second, the idea that a company or fund’s value on the market should reflect its expected future earnings. A rising value suggests that the company or fund’s future earnings will perform better in a warming, decarbonizing, and/or electrifying world. The flip side of this is that companies and funds out of vogue see their market value suffer as investors sell their stake in these companies to chase what they believe to be greener (pun not intended) pastures. This trend has been acutely felt across the oil and gas industry, with the upstream sector facing the most scrutiny for its perceived impact on the environment. Abandoning investment in traditional energy companies in favor of those perceived to be “greener” is, for a variety of reasons, a mistake, largely attributable to an inaccurate perception of the industry.

Fig. 4—The performance of the S&P Global Clean Energy Index as compared to the S&P 500. Source: The Economist.

The first reason for this is a lack of concrete metrics by which to evaluate an investment on the grounds of sustainability. An investment survey carried out by Pitchbook in 2020 revealed that the top sources of information on sustainable investing were webinars/conferences, white papers/case studies and sustainable investment organizations among others. Another study done by Schroders revealed that a plurality of the surveyed participants (34%) would only have full confidence in the sustainability prospects of a company if it were endorsed by an independent third party. Investors endorsed sustainability-related groups like the Global Reporting Initiative (GRI), Principles for Responsible Investment, Task Force on Climate-related Financial Disclosures among others (Fig. 5).

Fig. 5—Participation or endorsement of sustainability-related group by survey takers. Source: Pitchbook 2020 Sustainable Investment Survey.


The absence of a common standard, in combination with its newness and voluntary nature, has led to significant variation in the measurement and reporting of ESG metrics. Some of the top organizations helping with reporting frameworks and guidance are the Sustainability Accounting Standards Board, Global Reporting Initiative (GRI), and the Task Force on Climate-related Financial Disclosures. Others include the International Petroleum Industry Environmental Conservation Association, the International Association of Oil and Gas Producers, and the American Petroleum Institute—who jointly developed industry-specific guidance for sustainability reporting. This guidance takes some of its inspiration from the GRI framework. Each framework has a slightly different focus. Despite sharing an overarching goal, the varied nature of these numerous frameworks and the absence of a globally recognized set of ESG metrics has made it a challenge to sort through and compare results among companies.

Without an officially verified or enforced metric, the door is also open for “greenwashing" or “the practice of governments and companies misrepresenting environmental benefits to seduce ethical investors.” Greenwashing uses marketing spin to take advantage of the surging demand for sustainable investment products. This makes things even more difficult for the values-driven investor to authenticate claims of credentials or the price to emissions value of an investment. This in turn makes it more difficult for the companies who are trying to prove their commitment to sustainable causes and possess the mettle for innovation to access sorely needed capital. Among other solutions, improved disclosures would help alleviate the problem of asymmetric information that creates this market inefficiency.

However, this would not fully solve the problems with sustainable investing: There is evidence to suggest that there may be a disconnect between the current ESG reporting and innovation for sustainability. A paper published by the European Corporate Governance Institute explores this thesis. Their work finds that much of the leading green innovation and resulting patents (between 2008 and 2017) are not driven by the firms with high ESG ratings, commonly favored by ESG funds, but instead by traditional energy sector firms that are excluded, whether implicitly or explicitly, from this investment sphere. The green patents of these firms are also of significantly higher quality than those held by higher-rated ESG firms. The paper also demonstrated that the creation of green patents by traditional energy sector firms is hardly new. An example of that is the fact that one of the most important and foundational patents in solar technology was filed by filed by Exxon in 1978. This suggests that there exists a negative perception gap between ESG reporting metrics and the reality of what (and who) has been driving high-impact sustainable innovation.

Finally, natural gas is the transition fuel of choice, allowing electricity generation to move away from energy sources with greater environmental impact, such as coal, while building renewable capacity. Without a boom in nuclear power, natural gas is also well positioned to remain the backup generation fuel of choice for when the sun is not shining, or the wind is not blowing. The recent spike in global gas prices due to an impending global shortage during the Northern hemisphere’s winter is a testament to its continued importance in the global energy makeup.

As the trend towards sustainable investing continues to grow and evolve, it poses a challenge to traditional energy sector firms to become proactive about addressing how their work and its impact are perceived by both the public and the markets. Poorly formulated metrics would continue to exclude incumbent oil and gas companies, whose established infrastructure and energy expertise will be invaluable in any energy transition, from traditional sources of funding. This perception battle is critical as it is already governing access to billions of dollars of capital. That in turn could ultimately decide who wins or loses in the market.

If approached correctly, sustainable investing presents an opportunity for oil and gas companies to map a realistic road forward. This should not be a stretch given the amount of energy innovation, past and present, and the social impact the industry has and continues to contribute to the communities they operate in. Traditional energy firms need to engage more with all stakeholders to help standardize ESG reporting for transparency and clarity in a manner that will accurately capture the value that the industry has brought and continues to bring to the quest for a sustainable and energy abundant future. Properly managed, such a course will, at the same time improve the perception of the industry in the eyes of both the public and the market, maintaining access to channels of funding that will be critical if they are to continue to be pioneers in any energy transition.