This article is sponsored by Goldman Sachs
Environmental, social and governance investing has been top of mind for many investors over the last few years, but the events of 2020 are likely to give this theme – and its more focused cousin, impact investing – additional momentum. The visible effects of climate change, a pandemic and social unrest have created a renewed focus on sustainability from both the business community and broader public alike.
This trend is likely to have knock-on effects for private investments. We caught up with industry veteran Ken Pontarelli, who recently re-joined Goldman Sachs as a partner to lead a new group focused on sustainable investing in the firm’s Alternatives business, to get his views on ESG trends and opportunities in private markets.
You have been investing in ESG-related opportunities for many years now. Why did you become interested in this area?
I started to focus on impact investing through a combination of deeply personal views and the commercial benefits of investing according to ESG principles.
We have a climate crisis looming large and there are many pressing social issues that need to be addressed. It is evident that these challenges will not be solved by government action and philanthropy alone. It will take massive amounts of capital for us to stay on the right side of the climate ledger, for example.
On the commercial side, we now see compelling tailwinds driving ESG investment. Even if you do not have a personal interest in ESG, it is hard to ignore the financial case today for investing according to these principles.
After leaving Goldman Sachs in 2017, you established your own firm, Mission Driven Capital Partners. What was behind that move?
I saw a gap in the market. I care deeply about social and environmental issues, and there was a scarcity of classically trained private equity investors sourcing ESG opportunities, so it seemed like a natural move. The firm was intended to fill the gap between early-stage venture capital and infrastructure, which is later stage and lower risk. Our aim was to provide growth capital that generated a positive and measurable impact alongside financial returns.
Now that you are back at Goldman Sachs, where will your focus lie?
I had previously worked at Goldman Sachs for 25 years, so I knew that the firm’s commitment to sustainability was a priority for our Executive Office. I could see that I would have a far greater impact if I re-joined a firm with significant investors and corporate relationships than I could in a third-party firm.
In our new group, we plan to provide growth capital to businesses with products and services that help companies operate sustainably in a cost-effective way. You need to be able to satisfy both the chief sustainability officer and the CFO, who cares mostly about the bottom line.
The sectors we plan to target are fairly broad but they are all connected by an environmentally and socially conscious approach – clean energy, sustainable transport, sustainable food and agriculture, waste and materials and ecosystem services. For example, we might finance a company that produces cost-effective substitutes for plastics in packaging – that kind of product would be at the top of the list for every major consumer goods company to help them meet their sustainability objectives.
What have been the most important recent developments in ESG investing?
ESG investing has gained an enormous amount of traction in a relatively short period of time. This year, in particular, has raised awareness about the gravity of the problems we are facing on a global scale. The wildfires in Australia and California, for example, have really personalised the impact of climate change as we see the results unfolding in more extreme ways than had previously been predicted. On the “S” – social side – we have seen systemic injustice highlighted this year, while employees, customers, suppliers and investors have been demanding that companies operate with a higher standard of care than ever before.
Ten years ago, only a relatively small amount of capital was directed towards opportunities that had an ESG angle; today, almost a third of public market capital is being invested in ESG-related strategies. Almost every Fortune 500 company now produces a sustainability report. We are starting to see similar developments in private markets, where currently only a small fraction of the capital is committed to ESG and impact investments – but that is changing, and I think the shift will happen quickly.
Has the argument around returns and sustainability now been won?
I still see some degree of scepticism. Some people still believe ESG investments must translate to concessionary returns, particularly in private markets. I can understand why; there were a few waves of “green tech” investments that did not pan out as expected.
However, the landscape is fundamentally different today. In renewable energy, for example, some companies made promises around energy transition in the past, but they weren’t on firm footing – many were funded too early or perhaps should never have received funding. Today, the cost of energy from renewable sources has fallen and renewables are often more cost-effective than fossil fuels. The kind of progress made in power and renewables 15 to 20 years ago is starting to play out in other areas, such as plastic alternatives and water usage. Companies targeting these spaces now make strong economic propositions, as well as sustainable ones.
We believe that we are on the verge of a highly attractive ESG-oriented investing environment, and consequently, we think that the amount of capital lining up behind ESG in private markets is poised to grow.
How much of an effect has the pandemic had on ESG investing?
In the early stages, there were concerns that ESG and sustainability would take a back seat – that they were only issues to be addressed when times were good. If anything, the pandemic has only reaffirmed the business community’s commitment to operating sustainably. Many business leaders see covid-19 as an issue for the next 18 months or so, but they recognise that climate change will be an issue for the next several decades.
People now also recognise how rapidly things can change, and that businesses need to have the agility to pivot and the resilience to bounce back quickly from challenges. Increasingly, people are starting to realise that sustainability plays an important role in this. Building strong and positive relationships with employees, suppliers, customers and investors promotes resilience – corporations today can no longer afford to have a singular focus on the bottom line.
What are the most challenging aspects of ESG investing?
There is a lot of focus on measurement of ESG metrics, and the practice is evolving. It takes a significant amount of work and close partnership with portfolio companies to aggregate ESG information and report on an entire portfolio of investments. It can also be difficult to measure both direct and ancillary ESG impact. That can lead some investors to throw up their hands in frustration because they want a path to standardised information, approaches and measures. The industry will eventually find an approach that works well for all stakeholders, but it will take time.
In the meantime, we can customise metrics that are most relevant to each company and the impact they are intended to produce. The benefits of renewable energy, for example, are very different from those of substitutes for plastic packaging, and the metrics that measure their success should be tailored accordingly.
How do you see ESG and impact investing evolving over the coming years?
I hope that in five years’ time we can look back and say that this was a great time for ESG and sustainable investing. There is a scarcity of capital right now but plenty of opportunity, and that has the potential to produce a strong return profile. This is what I was hoping to do when I returned to Goldman Sachs – make impact-oriented investments that generate the returns of traditional private equity. And if that prediction holds true, it may drive other firms to integrate ESG into their processes. Over the medium term, I see the majority of private equity firms integrating ESG until it simply becomes part of a daily routine, and expect a lot of opportunity in this space going forward.