Greenwashing and broken markets create opportunities for small-cap investors.
ESG capital realignment will pivot to science-based emerging companies.
The headlines have been dominated by the collapse of ESG bonds and ESG ETF funds. ESG is being sucked into the 'culture wars'. The moves by the SEC and the EU on greenwashing are already driving change. This is shaping how investors understand the market. As noted previously, the next phase will be litigation of funds, institutions, and companies.
Withdrawals due to lack of impact
From talking with investors and analysts, this is not purely true. The withdrawals are not all based on performance. Instead, withdrawal decisions are based on impact and not achieving Carbon, Climate, and Biodiversity targets. Investors at all levels feel they have ‘been sold a kipper’.
The capital is still available.
Headlines saying that capital withdrawal indicates the end of ESG investing, which could imply nothing is done about climate risk, are false. There is a market realignment. Capital is being withdrawn while investors can identify science-based assets to deliver impact.
Losers
The sticky wicket is for the institutions and fund managers who have promoted ETFS and 'green bonds' via ESG rating—presenting assets as having an impact and "being green". Of course, in a true sense, "being green' is a fallacy; in the purest sense and despite net zero, we will all emit some carbon, and really, I don't think that is the point of what we are doing, but that is for another day. However, these institutions now need to conduct an ‘about face’ to regain the confidence of impact-focused investors.
Winners
Winners will be the company's intent on avoiding ESG greenwashing, i.e., science-based measurement. These enable companies for the future of the circular economy and energy transition, demonstrating they are part of the solution. In addition, as previously noted, reform of capital markets instruments such as green bonds would help these companies.
How to access capital
To access the ESG capital, these companies must first prove they are generating green revenues. Secondly, demonstrate they are allocating CAPEX to critical climate solutions and technologies. Thirdly, they must develop strong narratives about how they are the 'real deal', emerging companies that will challenge the larger immobile incumbents in their sectors and bring forward the circular economy.
Opportunity for small-cap investors
Most of these companies are below £500M and will seek funding. They don't suffer the issues of the incumbent; they are agile, CEO and CFO’s can make decisions. Because of their size, they can adapt more quickly to science-based targets (Climate, Carbon, Biodiversity). Once in place, they are easy to sell and promote to ESG capital fund managers and investors, including family offices that want to demonstrate they understand how to make returns from impact investing.
More difficult conversations
Even after the most memorable month of May 2022, which I think will be historical, in the history of climate and capital markets, ESG is still very difficult to discuss. I do not believe we have developed the correct language and phrases that will connect science to the capital. As a phrase, in ten years, ESG will not exist. Instead, analysts and the market will include carbon, climate, and biodiversity positive and negative impacts as part of the valuation.
JM
