Investing in the Anthropocene

Geography, Environment, and Systems Sustainability

The elusive search for favorable and uncorrelated returns across asset classes has pushed investors in recent years into the space of alternative data, with the hopes of discovering new, untapped sources of information that can be acquired, analyzed and transformed into a sustainable market advantage.  This occurs in financial services through the trader’s ongoing quest for new sources of alpha, as well as in the private equity/venture capital arena, where investors are looking for differentiated and scalable ideas that will become the companies of tomorrow.  In either case, new data is accompanied by new investable themes, and one theme which has been gaining in popularity falls under the Environmental, Social & Governance, or ESG, umbrella.  ESG has been around in some fashion for decades, but to date it has been more marketing than substance.  Further, upon closer examination of what comprises most ESG efforts, we see that it carries very little true meaning as it relates to financial performance or to true environmentally responsible investing.  Therefore, it is time to rebrand ‘ESG’ as ‘GESS’ and with this will come an approach towards investing with a more technical and global purview: the updated GESS should focus on investable themes that complement one another to connect companies, natural and industrial ecosystems, and markets under the moniker of Geography, Environment, and Systems Sustainability.

The rise of ESG themes, as well as the funds marketing these themes to prospective clients, highlights the need to explore investable ideas that demonstrate a return while also providing a hedge against corrupt business practices.  However, when we look closer at how these measures are generated and quantified, many of today’s ESG scores are largely assigned based on factors related to softer criteria.   Some of these include the strength of the leadership team, higher-level emissions data released through disclosures, public perception, number of fines/citations, supplier certifications, etc.   The majority of these are subjective measures, or they are benchmarked against a baseline with little meaning.  In any case, they also do not assess how a company operates within the larger system of multi-continental industries, where regulatory measures span many jurisdictions.  In contrast, a truly meaningful GESS strategy grounded in actual (physical, chemical, ecological) data related to industrial output proxies can uncover a more representative suite of characteristics related to how sectors and companies perform, how they can be scored, and ultimately how they rank. For the purposes of building a new definition of strategies that benefit both economy and environment, a framework for the ESG to GESS transformation should contain the following elements:

Geography:                Rather than focusing on single companies and their upstream suppliers, fundamental analysts should develop a read on the operations of a company as examined through a global geographic lens.  As supply chains have become global, single-country origins are not as meaningful as they once were; supplier networks become more important than country of origin.  This new geography also takes into account both social and physical characteristics of commerce, including trade routes and partners, biogeochemical and climatic cycles impacting raw material sourcing, foreign exchange exposures and geopolitical implications of trade, resource use and cooperation.

Environment:            How do we define the true environmental performance of a company?  How do they lead in environmental performance with respect their operating sector?  Today, ESG analysis looks at 5-10 year plans, and how companies improve against in-house benchmarks.  This tends to become arbitrary at best, sandbagging at worst.  Looking at an accurate and representative environmental footprint of a company requires not only assessing progressive changes in emissions reductions which are linear, but also step changes in efficiency technology adaptation around managing waste, raw material spend, and use of alternatives, all of which carry exponential benefits.

Systems:            Pulling from the complexity sciences, a systems approach looks at agents within a system and examines how they operate in concert with one another, how they evolve, and how new properties emerge.  Taking this application to the examination of industrial ecosystems, a holistic systems approach will look at how agents within a sector influence behavior of cohorts, emergent inter and intra-sector properties, and the impact of incentives and disruptors.  This approach also lends itself to borrowing algorithms from th evolutionary sciences, leading to new tools for examining systemic risk, something sorely needed in traditional ESG analysis.

Sustainability:         G+E+S=S.  A revamped measure of sustainability, therefore, is a synthesis of the three components described above.  Sustainable investments, and the businesses that they represent, will take all three of these components into account, and this also will allow for a unique view when attempting to compare companies in different sectors – something that proves to be quite difficult under current ESG methodology.

As the GESS framework evolves, the information and insights generated will serve as raw material for both fundamental and quantitative investors.  This should in turn increase both the depth and breadth of the data and methods that will be used to assess environmental and economic potential and performance.  In addition, we should see a demand catalyst for technology/data transfer, as Universities, National Laboratories, and startups germinated in academia are searching for more avenues to apply research and technology findings.  Hopefully, the data-as-a-service model will stimulate incentives for all types of scientific data, typically not the domain of investors.

Future articles will take a deeper look at specific examples where scientific data coupled with a systems approach can generate insights regarding micro and macro behavior as it relates to firms, sectors and economies.  This should be of interest to investors, analysts and possibly most importantly, risk managers.

(This article is cross-posted in Medium)

Feel free to contact Atlas Research Innovations to learn more.

 

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