Why ESG Investing Thrives In Chaotic Times

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Another COVID-19 variant; Melting ice caps cause cities to sink below the water level; Wars breaking out over diminishing supplies of potable water. Cyberattacks bankrupting global corporations and crippling governments. Corrupt autocrats plundering their countries for wealth and power.

They aren’t just dystopian fantasies. Some are already occurring around the world. They’ll likely only increase in the coming year and decade. Each could exert a monumental impact on our lives – and on markets. Yet the impact won’t be uniformly negative. For investors, alpha is possible amid the chaos.

The trick is adopting a mindset to take advantage of the possibilities that disruption brings. In his groundbreaking book, “Antifragile: Things That Gain from Disorder,” Nassim Nicholas Taleb makes the case for that mindset, explaining how especially resilient individuals, systems and societies can not only withstand uncertainty, shocks and disruptions but gain from the adversities thrown at them.

“Wind extinguishes a candle and energizes fire,” Taleb writes. “Likewise with randomness, uncertainty, chaos: you want to use them, not hide from them. You want to be the fire and wish for the wind.”

Nobody is rooting for disasters to strike. But everyone must accept that a certain level of chaos and calamity is inevitable – and that simply weathering these crises isn’t enough. Savvy investors welcome the upheaval and the comparative advantages it brings. Perhaps antifragility is an idea that needs to be applied to environmental, social and governance (ESG) investing.

ESG beyond risk mitigation

ESG investing involves companies and funds that address the potential negative effects of climate change, financial meltdowns and other disasters while also actively working to address the root causes of potential chaos.

ESG investing is often seen as a risk mitigator — and if structured correctly could be a strategy for avoiding what Taleb describes as “Black Swans,” or unexpected disruptions to the status quo. There is ample evidence that employing ESG principles in investing reduces downside risk related to climate change, corruption, gender bias and cyberattacks.

An antifragile approach to investing goes a step further, however. Taleb describes antifragility as a combination of paranoia and aggressiveness. Accordingly, investors can use the expanding universe of ESG reporting from public and private companies to aim for alpha. The idea is to identify opportunities to profit from, not just survive the disarray.

Marrying positive change and profit

 Although ESG investing has moved into the mainstream of the global financial system, plenty of skeptics remain — including investors who see no reason to complicate the drive for profit. But the dichotomy of positive change versus profit is a false one.

The same ESG principles that funnel money into sustainable companies are also creating long-term growth. Moreover, this investing helps markets confront existential threats rather than relying on government regulations and other mandates. Think green new deal spending, investing in female and black-owned enterprises and reassessing financial chicanery. Investors ignoring ESG concerns do so at their own peril.

Yet ESG investing is no guarantee of success. And it can be hard to discern which companies are truly addressing ESG risks and which ones are paying lip service or even cooking the books, or greenwashing. Now is when the best investors will seize the best deals, before the dust clears and ESG rules solidify

In both Europe and the United States, regulators and lawmakers are now watching this space closely and taking action against fraud. As of March, financial actors in Europe are subject to new rules around ESG disclosures. U.S. regulators have made non-financial data an “examination priority” in 2021.

Investing in domain expertise — and unique data

For investment advisers and asset managers, ESG investing has created a new universe of data. But unlike financial reporting, which these actors have teams of professionals to analyze, the strategy around ESG analysis is often a work in progress. The skills are not always transferable, either.

Investors who want to jump ahead in the ESG space are looking for outside help – entities with a proven track record of finding alpha in ESG data and building antifragile positions into investment portfolios.

It’s not only happening with public companies, where ESG disclosures can be easily scraped for relevant data. Private investors are also realizing the profit-making potential of collecting ESG data on private companies and looking for partners with domain expertise.

Whatever associations ESG investing has accumulated in its infancy, it’s appeal is expanding to investors of all political and philosophical stripes. Across these divides, the same realization is settling in – the greatest threats to the world also represent the greatest downside risks for investors. But there’s another side of that trade, of course.

During times of chaos, you better hitch your funds to antifragile investments. Because that is how you get alpha and perhaps create a more antifragile world along the way.

Jason Meklinsky is Head of Americas Business Development, Hedge Funds, Private Equity, Real Estate and VC at Apex Group.