The Siren Song of Sustainability: The Theocratic Trifecta's Third Leg!

    You might know, by now, of my views on ESG, which I have described as an empty acronym, born in sanctimony, nurtured in hypocrisy and sold with sophistry. My voyage with ESG began with curiosity in my 2019 exploration of what it purported to measure, turned to cynicism as the answers to the Cui Bono (who benefits) question became clear and has curdled into something close to contempt, as ESG advocates rewrite history and retroactively change their measurements in recent years. Earlier this year, I looked at impact investing, as a subset of ESG investing, and chronicled the trillions put into fighting climate change, and the absence of impact from that spending. Sometime before this journey, I also looked at the notion of stakeholder wealth maximization as an idea that only corporate lawyers and strategists would love, and argued that there is a reason, in conventional businesses, that we stay focused on shareholders and that it is both impractical and unwise to try to play the stakeholder game. With each of these topics (ESG, impact investing, stakeholder wealth maximization), the response that I got from some of the strongest defenders was that "sustainability" is the ultimate end game, and that the fault has been in execution (in ESG and impact investing), and not in the core concept.  

    I was curious about what sets sustainability apart from the critiqued ideas, as well as skeptical, since the cast of characters (individual and entities) in the sustainability sales pitch seems much the same as for the ESG and stakeholder wealth sales pitches.  In critiquing sustainability, I may be swimming against the tide, but less so than I was five years ago, when I first wrote about these issues. In fact, in my first post on ESG, I confessed that I risked being labeled as a "moral troglodyte" for my views, and I am sure that my subsequent posts have made that a reality, but I have a thick skin. This post on sustainability will, if it is read, draw withering scorn from the righteous, and take me off their party invite list, but I don't like parties anyway.

Sustainability: The What, the Why and the Who?

    I have been in business and markets for more than four decades, and while sustainability as an end game has existed through that period, for much of it, it was in the context of the planet. It is in the last two decades that corporate sustainability has become a term that you see in academic and business circles, albeit with definitions that vary across users. Before we look at how those definitions have evolved, it is instructive to start with three measures of sustainability, measuring (in my view) very different things:

• Planet sustainability, measuring how our actions, as consumers and businesses, affect the planet, and our collective welfare and well being. This, of course, covers everything from climate change to health care to income inequality.
• Product sustainability, measuring how long a product or service from a business can be used effectively, before becoming useless or waste. In a throw-away world, where planned obsolescence seems to be built into every product or service, there are consumers and governments who care about product sustainability, albeit for different reasons.
• Business or corporate sustainability, measuring the life of a business or company, and actions that can extend or constrict that life. 

There are corporate sustainability advocates who will argue that it is all of the above, and that a business that wants to increase its sustainability has to make more sustainable products, and that doing so will improve planet sustainability. That may be true, in some cases, but in many, there can be conflicts. A company that makes shaving razors may be able to create razor blades that stay sharp forever, and need no replacement, but that increased product sustainability may crimp corporate sustainability. In the same vein, there may be some companies (and you can let your priors guide you in naming them), whose very existence puts the planet at risk, and if planet sustainability is the end game, the best thing that can happen is for these companies to cease to exist. 

    

    Which of these measures of sustainability lies at the heart of corporate sustainability, as practiced today? To get the answers, I looked at a variety of players in the sustainability game, and will use their own words in the description, lest I be accused of taking them out of context:

• Business schools around the world have discovered that sustainability classes not only draw well, and improve their rankings (especially with the Financial Times, which seems to have a fetish with the concept), but are also money makers when constructed as executive classes. NYU, the institution that I teach at, has an executive corporate sustainability course, with certification costing $2,200, but I will quote the Vanderbilt University course description instead, where for a $3,000 price tag, you can get a certificate in corporate sustainability, which is described as " a holistic approach to conducting business while achieving long-term environmental, social, and economic sustainability." 
• Academia: I read through seminal and impactful (as academics, we are fond of both words, with the latter measured in citations) papers on corporate sustainability, to examine how they defined and measured sustainability. A 2003 paper on corporate sustainability describes it as recognizing that " corporate growth and profitability are important, it also requires the corporation to pursue societal goals, specifically those relating to sustainable development — environmental protection, social justice and equity, and economic development." In the last two decades, it is estimated that there have been more than twelve thousand articles published on corporate sustainability, and while the definition has remained resilient, it has developed offshoots and variants.
• Corporate/Business: Companies, around the world, were quick to jump onto to the sustainability bandwagon, and sustainability (or something to that effect) is part of many corporate mission statements. The Hartford, a US insurance company, describes corporate sustainability as centered "around developing business strategies and solutions to serve the needs of our stakeholders, while embracing the necessary innovation and foresight to ensure we are able to meet those needs in the decades to come."
• Governments: Governments have also joined the party, and the EU has been the frontrunner, and its definition of corporate sustainability as "integrating social, environmental, ethical, consumer, and human rights concerns into their business strategy and operations" became the basis for both disclosure and regulatory actions. The Canadian government has used to EU model to create a corporate sustainability reporting directive, requiring companies to report on and spend more on a host on environmental, social and governance indicators. 

I am willing to be convinced otherwise, but all of these definitions seem to be centered around planet sustainability, with varying motivations for why businesses should act on that front, from clean consciences (it is the right thing to do) to being "good for business" (if you do it, you will become more profitable and valuable).

    While corporate sustainability has taken center stage in the last two decades, it is part of a discussion about the social responsibilities of businesses that has been around for centuries. From Adam Smith's description of economics as the "gospel of mammon" in the 1700s to Milton Friedman's full-throated defense of business in the 1970s, it can be argued that almost every debate about businesses has included the component of what they should do for society, beyond just following the law. That said, corporate sustainability (and its offshoots) have clearly become a much bigger part of business  than ever before, and one manifestation is in the rise of "corporate sustainability officers" (CSOs) at many large companies. A PwC survey of 1640 companies in 62 countries, in 2022, found that the number of companies with CSOs tripled in 2021, with about 30% of all companies having someone in that position. A Conference Board survey of hundred sustainability leaders (take the sample bias into account) of the state of corporate sustainability pointed to the expectation that sustainability teams at companies would continue to grow over time. Finally, going back to academia, an indicator of the buzz in buzzwords, a survey paper in 2022 noted the rise in the number of corporate-sustainability related articles in recent years, as well as documenting their focus:

Burbano, Delma and Cobo (2022)

Note that much of the surge in articles came from ESG, which at least for the bulk of this period marched in lockstep with sustainability. Reflecting that twinning, many of the papers on corporate sustainability, just like the papers on ESG, were framed as sustainability being not just good for society but also good for the companies that adopted them. 

    I will admit that I have no idea what a CSO is or does, but I did get a chance to find out for myself, when I was invited to give a talk to the CSOs of fifty large companies. I started that session with a  question, born entirely out of curiosity, to the audience of what they did, at their respective organizations. After about twenty minutes of discussion, it was very clear that there was no consensus answer. In fact, some were as in the dark, as I was, about a CSO's responsibilities and role, and among the many and sometimes convoluted and contradictory answers I heard, here was my categorization of potential CSO roles:

1. CSO as Yoda: Some of the CSOs described their role as not only providing vision and guidance to the companies they worked at, about the societal effects of their actions, but doing so with a long term perspective. In short, even though they did not make this explicit, they were projecting that they had the training and perspective on how the company and society would evolve over time, and advice the company on the actions that it would need to take to match that evolution. I was tempted, though I restrained myself, to ask what training they had to be such receptacles of wisdom, since a degree or certification in sustainability clearly would not do the trick. I did dig into Star Wars lore, where it is estimated that it takes a decade or two of intense training to become a Jedi, and left open the possibility that there may be an institution somewhere that is turning out sustainability jedis.
2. CSO as Jiminy Cricket: I am a fan of Disney movies, and Pinocchio, while not one of the best known, remains one of my favorites. If you have watched the movie, Jiminy Cricket is the character that sits on Pinocchio's shoulder and acts as his conscience, and for some of the CSOs in the audience, that seemed to be the template, i.e., to act as corporate consciences, reminding the companies that they work for of the social effects of their actions. The problem, of course, is that like the Jiminy Cricket in the movie, they are relentless scolds, usually get ignored, and get little glory, even when proved right. 
3. CSO as PR Genius: While relatively few CSO admitted to this, there were a few who were open about the fact that they were effectively marketing fronts for companies, with the job of taking actions that could not remotely be argued as being good for the planet and selling them as such. I am not sure whether Unilever's CSO was involved in the process, but the company's push to have each of its four hundred brands have a social or environmental purpose falls into this realm. 
4. CSO as Embalmer: Finally, there were some CSOs who argued that it was their job to ensure that the company would live longer, perhaps even forever. Like the embalmers who promised the Egyptian pharaohs everlasting life, if they wrapped themselves in bandages and buried themselves in crypts, these CSO view longer corporate lives as the end game, and act accordingly. 

Here are the roles in table form, with the training that would prepare you best for each one:

I am sure that I am missing some of the nuance in sustainability, but if so, remember that nuance does not survive well in business contexts, where a version of Gresham's law is at work, with the worst motives driving out the best.

Sustainability and ESG

    In the last two or three years, corporate sustainability advocates have tried to separate themselves from ESG, arguing that the faults of ESG are of its own doing, and came from ignoring sustainability lessons. I am sorry, but I don't buy it. If ESG did not exist, sustainability would have had to invent it, because much of the growth in sustainability as a concept and in practice has come from its ESG arm. As I see it, ESG took the noble sounding words of corporate sustainability and converted it into a scoring mechanism, and it was that much maligned scoring mechanism that caused a surge of adoptions both in corporate boardrooms and in investment funds. To complete the linkage, both ESG and sustainability draw on the stakeholder wealth maximization thesis, with the argument that businesses should be run for the benefit of all stakeholders, with society being one of the stakeholders, rather than for shareholders. It is in this context that I used the "theocratic trifecta" to describe how ESG, sustainability and stakeholder wealth are linked, and have been marketed. 

    While the ESG scoring mechanism, by itself, can be viewed as having a good purpose, i.e., create a measure of how much a company was moving towards it sustainability goals, and to hold it accountable, it created the natural consequences that come with all scoring mechanisms:

• Measurers (like Sustainalytics, S&P), all claiming to be objective arbiters, when the truth is that all scores require subjective judgments about good and bad, and the consequences for business profitability and value.
• Businesses that start to understand the drivers of scores, and then game the scoring systems to improve their scores. Greenwashing is a feature of ESG, not a bug, and the more you try to refine the scoring, the more sophisticated the gaming will become.
• Advocates wringing their hands about the gaming, and arguing that the answer is more detailed definitions of things that defy definition, not recognizing (or perhaps not caring) that this just feeds the cycle and creates even more gaming.
• Governments that think that creating one standard for what's in the best interests of society, and requiring companies to disclose everything that they do that can create costs for society, will make all the problems go away.

In fact, taking a step back and looking at ESG and sustainability as concepts, they share many of the same characteristics:

1. They are opaque: Both ESG and sustainability are opaque to the point of obfuscation, perhaps because it serves the interests of advocates, who can then market them in whatever form they want to. To the pushback from defenders that the details are being nailed down or that there are new standards in place or coming, the argument runs hollow because the end game seems to keep changing. With ESG, for instance, the end game when it was initiated was making the world a better place (doing good), which evolved to generating alpha (excess returns for investors), on to being a risk measure before converting on a disclosure requirement. Defenders argue that there will be convergence driven by tighter definitions from regulators and rule makers, and the EU, in particular, has been in the lead on this front, putting out a Corporate Sustainability Reporting Directive (CSRD) in 2022,  outlining economic activities that contribute to meeting the EU’s environmental objectives. While ESG advocates may be right about convergence, looking to the the bureaucracy in Brussels to have the good sense (on economics and sustainability) to get this right is analogous to asking a long-time vegan where you can get the best steak in town. 
2. They are rooted in virtue: While some of the advocates for ESG and sustainability have now steered away from goodness as an argument for their use, almost every debate about the two topics eventually ends up with advocates claiming to own the high ground on virtue, with critics consigned to the other side. 
3. Disclosures, over actions:  The path for purpose-driven concepts (sustainability, ESG) seems to follow a familiar arc. They start with the endgame of making the world a better place,  are marketed with the pitch that purpose and profits go together (the original sin) and when the the lie is exposed, are repackaged as being about disclosures that can be used by consumers and investors to make informed judgments. Both ESG and sustainability have traversed this path, and both seem to be approaching the "it's all about disclosure" component. While that seems like a reasonable outcome, since almost everyone is in favor of more information, there are two downsides to this disclosure drive. The first is that disclosure can become not just a substitute for acting, but an impediment to the change that makes a difference.  The second is that as disclosures become more extensive, there is a tipping point, especially as the consequential disclosures are mixed in with minor ones, where users start ignoring the disclosure, effectively removing their information value. 
4. Underplay or ignore sacrifice: Of all the mistakes, the biggest one made in the sales pitch for ESG and sustainability was that you could eat your cake, and have it too. Companies were told that being sustainable would make them more profitable and valuable, investors were sold on the notion that investing in good companies would deliver higher or extra returns and consumers were informed that they could make sustainable choices, with little or no additional cost. The truth is that sustainability will be costly to businesses, investors, and consumers, and why should that surprise us? Through history, being good has always required sacrifice, and it was always hubris to argue that you could upend that history, with ESG and sustainability.

Notwithstanding the money, time and resources that have been poured into ESG and sustainability, there is little in terms of real change on any of the social or climate problems that they purport to want to change. 

Can sustainability be saved?

    

    I may be a moral troglodyte, because of my views on ESG, sustainability and all things good, but I want my children and grandchildren to live in a better world than the one that I lived in. Put simply, we have a shared interest in making the world a better place, and that leads to  the question of whether corporate sustainability, or at least the mission that it espouses, can be saved. I believe that there is a path forward, but it requires steps that many sustainability purists may find anathema:

1. Be clear eyed about what can be achieved at the business level: There is truth to the Milton Friedman adage that the business of business is business, not filling in for social needs or catering to non-business interests. It is true that there are actions that businesses take that can create costs to society, and even if the law does not require it, it behooves us all to get businesses to behave better. That said, the danger of overreaching here, and asking businesses to do what governments and regulators should be doing, is that it is not just ineffective but counter-production.  For business sustainability to deliver results, it has to make that line (between business and government action) clearer.
2. Open about the costs to businesses of meeting sustainability goals: Start being real about the sacrifices in profitability and value that will be needed for a company to do what's good for society. To the extent that in a publicly traded company, it is not the managers, but one of the stakeholders (shareholders, bondholders, employees or customer), who bear this cost, you need buy in from them, of the sustainability actions are voluntary. For companies that are well managed and have delivered success for their owners, the sacrifice may be easier to sell, but for badly managed businesses, it will be and should be a steep hill to climb. To the extent that corporate executives and fund managers have chosen the path of virtue, at a cost to their shareholders and investors, without their buy in, there is clearly a violation of fiduciary duty that will and should leave them exposed to legal consequences.
3. Clear about who bears these costs: I was recently asked to give testimony to a Canadian parliamentary committee that was considering ways of getting banks to contribute to fighting climate change (by lending less to fossil fuel companies and more to green energy firms), and much of what I heard from committee members and the other experts was about how banks would bear the costs. The truth is that when a bank is either restricted from a  profit-making activity or forced to subsidize a money-losing activity, the costs are borne by either the bank's shareholders or depositors, or, in some cases, by taxpayers. In fact, given that bank equity is such a small slice of overall capital, I argued that it bank depositors who will be burdened the most by bank lending mandates. 
4. And honest about cost sharing: One of the benefits of recognizing that being good (for the planet or society) creates costs is that we can then also follow up by looking at who bears the costs. It is my view that for much of the past few decades, we (as academics, policy makers and regulators) been far too quick to decide what works for the "greater good", at least as we see it, and much too blind to the reality that the costs of delivering that greater good are borne by the people who can least afford it. 
5. Above all,  drain the gravy train: Drawing on a biblical theme, both ESG and sustainability have been contaminated by the many people and entities that have benefited monetarily from their existence. The path to making sustainability matter has to start by removing the grifters, many masquerading as academics and experts, from the space. I won’t name names, but if you want to see who you should be putting on that grifter list, many of them will be at the annual extravaganza called COP29, where the useful idiots and feckless knaves who inhabit this space will fly in from distant places to Azerbaijan, to lecture the rest of us on how to minimize our carbon footprint. If you are a business that cares about the planet, fire your sustainability consultants, stop listening to sustainability advisors or bending business models to meet CSRD needs, and fall back on common sense, and while you are at it, you may want to get rid of your CSO (if you have one), unless you have Yoda on your payroll. 

In all of this discussion, there is a real problem that no one in the space seems to be willing to accept or admit to, and that is much as we (as consumers, investors and voters) claim to care about social good, we are unwilling to burden ourselves, even slightly (by paying higher prices or taxes), to deliver that good. It could be because we are callous, or have become so, but I think the true reason is that we have lost trust in governments and institutions, and who can blame us?  Whether it is the city of San Diego, where I live, trying to increase sales taxes by half a percent or a government imposing a carbon tax, taxpayers seem disinclined to given governments the benefit of doubt, given their history of inefficiencies and broken promises. 

    One argument that I have heard from many advocates for ESG and sustainability is that the pushback against these ideas is coming primarily from the United States, and that much of the rest of the world has bought in their necessity and utility. That is nonsense! I would suggest that these people leave the ivory towers and echo chambers that they inhabit, and talk to people in their own environs. There are many reasons that incumbent governments in Canada and France (both "leaders" in the climate change fight) are facing the political abyss in upcoming elections, but one reason is the "we know best" arrogance embedded in their climate change strictures and laws, combined with the insulting pitch that the people most affected by these laws will not feel the pain. 

    How do we get trust in institutions back? It will not come from lecturing people on their moral shortcomings (as many will undoubtedly do to me, after reading this) or by gaslighting them (telling them that they are better off when they are clearly and materially not). It will require humility, where the agents of change (academics, governments, regulators) are transparent about what they hope to accomplish, and the costs of and uncertainties about reaching those objectives, and patience, where incremental change takes precedence over seismic or revolutionary change. 

YouTube Video

My posts on ESG, impact investing and stakeholder wealth

1. From Shareholder Wealth to Stakeholder Interests: CEO Capitulation or Empty Doublespeak? (August 2019)
2. Sounding Good or Doing Good? A Skeptical Look at ESG (September 2020)
3. The ESG Movement: The "Goodness" Gravy Train Rolls On! (September 2021)
4. ESG's Russia Test: Trial by Fire or Crash and Burn? (March 2022)
5. Good Intentions, Perverse Outcomes: The Impact of Impact Investing (October 2023)

The Wisdom and Madness of Crowds: Market Prices as Political Predictors!

    In this, the first full week in November 2024, the big news stories of this week are political, as the US presidential election reached its climactic moment on Tuesday, but I don't write about politics, not because I do not have political views, but because I reserve those views are for my friends and family. The focus of my writing has always been on markets and companies, more micro than macro, and I am sure that you will find my spouting off about who I voted for, and why, off-putting, much as I did in his cycle, when celebrities and sports stars told me their voting plans. This post, though, does have a political angle, albeit with a market twist. During the just-concluded presidential election, we saw  election markets, allowing you to predict almost every subset of the election, not only open up and grow, but also insert themselves into the political discourse. I would like to use this post to examine how these markets did during the lead in to the election, and then expand the discussion to a more general one of what markets do well, what they do badly, i.e., revisit an age-old divide between those who believe in the wisdom of crowds and and those that point to their madness.

Election Forecasts: From polls to political markets

    I watched the movie "Conclave"just a couple of days ago, and it is about the death of a pope, and the meeting to pick a replacement. (It is based on a book by Robert Harris, one of my favorite authors.) In the movie, as the hundred-plus Catholic cardinals gathered in the Sistine chapel, to pick a pope,  I was struck by how the leading candidates gauged support and jockeyed ahead of the election, essentially informally polling their brethren. I know that the movie (and book) is fiction, but I am sure that the actual conclaves that have characterized papal succession for centuries have used  informal polling as a way of forecasting election winners for centuries. In fact, going back to the very first democracies in Greek and Roman times, where notwithstanding the restrictions on who could vote, there were attempts to assess election winners and losers, ahead of the event. 

    The first reported example of formal polling occurred ahead of the 1824 presidential election, when the Raleigh Star and North Carolina Gazette polled 504 voters to determine (rightly) that Andrew Jackson would beat John Quincy Adams. Starting in 1916, The Literary Digest started a political survey, asking its readers, and after correctly predicting the next four elections, failed badly in 1936 (predicting that Alf Landon would beat FDR in the election that year, when, in fact, he lost in a landslide). While polling found its statistical roots after that, it had one of its early dark moments, in 1948, when pollsters predictions that Thomas Dewey would beat Harry Truman were upended on Election Day, leading to one of the most famous headlines of all time (in the Chicago Tribune). In the decades after, polling did learn valuable lessons about sampling bias and with an assist from technological advancements, and the number of pollsters has proliferated. Coming into this century, pollsters were convinced that they had largely ironed out their big problems, but even at it peak, polls came with noise (standard errors), though pollsters were not always transparent about it, and the public took polling estimates as facts. 

    The fact that individual polls, even if not biased, are noisy (with ranges around estimates) led to a  poll aggregators, which collected individual polls and averaged them out to yield presumably a more precise estimate. Here, for example, is the aggregated value from Real Clear Politics (RCP), which has been doing this for at least four presidential election cycles now, leading into election days in the US (November 5):

While the original reason for aggregation was removing bias, aggregators can still induce bias by deciding which polls to include (and exclude) in their averages, and sometimes in how they weight these polls. While RCP computes simple averages, there are other aggregators who weight polls, based generally on their accuracy in prior elections, but bias enters in insidious ways.

    The pushback in poll-based forecasting (whether individual or aggregated) is that it may miss fundamentals on voter history and predilections, and in the last three cycles, there have been a few polling pundits who have used polling aggregates and their presumably deeper understanding of fundamentals to make judgments on who will win the election. Two are the best known are 538.com, a site that used to be part of the New York Times but is now owned by ABC, and Nate Silver's personal assessment, and leading into the election, here were their assessments for the election:

Both arrive at their estimates using Monte Carlo simulations, based upon data fed into the system. Note that polls, aggregated polls and poll judgment calls have run into problems in the last decade, some of which may be insurmountable. The first is the advent of smartphones (replacing land lines) and call screening allows callers to not answer some call, and polls have had to struggle with the consequences for sampling bias. The second is that a segment of the population has become tough, if not impossible, to poll, sometimes lying to pollsters, and to the extent that they are more likely to be for one side of the political divide, there will be systematic error in polls that will not average out, and those errors feed into polling judgments.

    With poll-based forecasts being less reliable and trusted, a vacuum opened up leading into the 2024 elections, and political markets have stepped into the gap. While it has always been possible to bet on elections, either in Las Vegas or through UK-based betting sites like Betfair, they are odd-driven, opaque and restricted. In contrast, Polymarket opened markets on US election outcomes (president, senate, by state, etc.), and through much of 2024, it has given watchers a measure of what investors in that market thought about who would win the election. In the graph below, you can see the Polymarket prices for a "Trump win" and a "Harris win" in the months leading into the election:

Note that until July, it was Joe Biden who was the democratic nominee for president, and the only portion of the graph that is relevant is the section starting in late July, when Kamala Harris became the nominee. 

    Mid-year, Polymarket was joined by Kalshi, structured very similarly, with slightly different rules on trading and transactions costs, and that market's assessment of who would win the market is below:

Since both markets existed in tandem for the months leading into the election, there were intriguing questions that emerged. 

• The first is that at almost every point in time, in the months that they have co-existed, the prices for a Trump or Harris win on the two pricing platforms were different, with the prices on Kalshi generally running a little lower than on Polymarket for a Trump win. 

In theory, this looks like an arbitrage opportunity, where you could buy the Trump win on the cheaper market and sell it on the more expensive one, but the transactions costs (1-2% in both markets) would have made them tough to pull off. 

• The second is that within each market, there were a proliferation of contracts covering the same outcome, trading at different prices. For instance, on Polymarket, you could buy a Trump win contract for one price, a a Republican win contract at a slightly higher price, leading into just last week, but that difference could just reflect concerns on mortality.

Do the actual results vindicate political markets? At least on this election, the answer is nominally yes, since the political markets attached a higher probability for a decisive victory for Trump in the electoral college than did the poll aggregators or judgments. However, political markets did not expect Trump to win the popular vote, which he may end up doing (some states are still counting), and that can be taken as evidence that markets can be surprised sometimes.  In the weeks leading into the election, there were two dimensions on which political markets varied from the polls and aggregators. On the plus side, the political markets were more dynamic, reflecting in real time, responses to events like the debates, interviews and endorsements; Polymarket's odds of a Trump win dropped by almost 10% after the debate. On the minus side, political markets were much more volatile than the polls, with swings driven sometimes by large trades; the Wall Street Journal highlighted one trader who put almost $30 million into the market on the Trump win, pushing up the price.

The Wisdom of Crowds

    That trust in crowd judgments in guiding our actions is not restricted to politics. In an earlier part of this post, I talked about going to the movies, and it is indicative of the times we live in that my movie choice was made, not by reading movie reviews on the newspaper, but by movie ratings on Rotten Tomatoes. Once the movie was done, the restaurant choice I made was determined by Yelp reviews, and without boring you further, you can see this pattern unfold as you think about how you choose the products you buy on Amazon or even the services (plumbing, electrical, landscaping) that you go with, as a consumer. On a less personal and larger scale,  the block chains that underlie Bitcoin transactions represent a crowd sourcing of the checking process (performed by institutions like banks conventionally), and you can argue that trusting social media to deliver you information is essentially crowd-sourcing your news.

   With these examples, you can see one of the dangers of crowd judgments, and that is that in all the crowds described above (Rotten Tomatoes, Yelp, Amazon product reviews and social media), there is no cost to entry, or to offer an opinion, and that can dilute the power of the judgments. In every one of these sites, you can game the system to give high ratings to awful movies and terrible restaurants, and social media news can be filled with distortions. With markets, we introduce an entry fee to those who want to join the crowd in the form of price, and demand more money to amplify those views.  In the words of Nassim Taleb, opinionated people with no skin in the game can make outlandish predictions, often with no accountability. If you don't believe me, watch the parade of experts and market gurus on any financial television channel, and notice how they are allowed to conveniently gloss over their own forecasts and predictions from earlier periods. In contrast, no matter what you think about the experience or motivations of traders on a market, they have to put money behind their views.

    When you use the price in a market as an assessment of the likelihood of an event, which is what you are implicitly doing when you trust Polymarket or Kashi prices as predictors of election winners, you are, in effect, trusting the crowd (albeit a selective one of those who trade on these markets) to be closer to the right outcome than polling experts or opinion leaders. When market price based forecasts are offered as alternatives to expert forecasts, the push back that you get is that experts have a deeper knowledge of what is being predicted. So, why do we trust and attach weight to the prices that investors assess for something? There are three reasons:

1. Information aggregation: One of the almost magical aspects of well-functioning markets is how pieces of information possessed by individual traders about whatever is being traded get aggregated, delivering a composite price that is effectively a reflection of all of the information. 
2. Real time adjustments to news: While experts (rightfully) take their time to absorb new information and reflect that information in their assessments, markets do not have the luxury of waiting. Consequently, markets react in real time, often in the moment, to events as they unfold, and studies that look at that reaction find that they often not only beat experts to the punch but deliver better assessments. 
3. Law of large numbers: It is true that individual traders in a markets can make mistakes, often big ones, in their assessments of value, and can sometimes also let their preconceptions and biases drive their trading. To the extent that these mistakes and biases can lie on both sides, they will average out, allowing the "right' price to emerge from several wrong judgments.

There is also a strand of research that is developing on the forecasting abilities of experts versus amateurs and it is not favorable for the former. Phil Tetlock, co-author of the book on super forecasting, chronicles the dismal record of expert forecasts, and argues that the best forecasts come from foxes (knows many things, but not in depth) and not hedgehogs (with deep expertise in the discipline). To the extent that a market is filled with amateurs, with very different knowledge and skill sets, Tetlock's work can be viewed as being supportive of market-based forecasts.

The Madness of Crowds

     Well before we had Rotten Tomatoes and Twitter were conceived, we had financial markets, and not surprisingly, much of the most interesting research on crowd behavior has come from looking at those markets.. Our experience there is that while markets allow for information aggregation and consensus judgments that are almost magical in their timeliness and assessment quality, they are also capable of making mistakes, sometimes monumental ones. One of my favorite books is Extraordinary Popular Delusions and the Madness of Markets, published in 1841, and it chronicles how market mistakes form and grow, using the South Sea Bubble and the Tulip Bulb Craze as illustrative examples. To those who believe that markets have somehow evolved since then to avoid these mistakes, behavioral finance provides the counter, which is that the behavioral quirks that gave rise to those bubble are still present, and may actually be amplified by technology and large platforms. The falsehood that was born in a pub in the South Sea bubble often looks weeks to work its way into market prices, but the same falsehood on a large social media platform today could affect prices almost instantaneously. 

    Without making this a treatise on behavioral finance, here are some of the problems that can lead markets off course, and make prices poor predictors of outcomes:    

1. Noise drowns out information: In finance, we use noise as a term to capture all of the stories and influences that should have no effect on value, but that can still affect prices. While noise exists in even the best-functioning markets, there is enough information in those markets to offset the noise effect, and bring prices back into sync with value. However, if noise is the dominant force in a market, it can drown out information, causing prices to delink from information. 
2. Momentum versus Fundamentals: On a related note, it is worth remembering that the strongest force in markets is momentum, where price movements are driven more by price movements in past periods, than by fundamentals. While in a well-functioning market, that momentum will  be checked by bargain hunters (if the price is pushed too low) or short sellers (if it is pushed too high), a market where one or the other of these players is either rare or non-existent can see momentum run rampant. It is one reason that I think that markets that restrict short selling, often labeling it as speculation, are creating the condition for market madness.
3. Participant bias: While markets require skin in the game from traders, that requires money, and that biases markets against people with little or no money. In political markets, for instance, it could be argued that the traders on Polymarket and Kalshi represent a subset of the population (younger, better off) that may differ from the voting population. 
4. Market Manipulation: The history of financial markets also includes clear cases where markets have been manipulated, to deliver profits to the manipulators. That problem becomes worse in markets with limited liquidity, where big trades can move prices, and where market insiders have access to data that outsiders do not. 
5. Illiquidity: All of the problems listed above become greater in a market where liquidity is light, since a large trade, whether motivated by noise, momentum or manipulation, will move prices more. 
6. Feedback loop: There are times where market prices can affect the fundamentals, and through them, the value of what is being traded. With publicly traded companies, a higher stock price, for instance, may allow the companies to issue shares at these higher prices, to finance investments and acquisitions. With the political markets, this feedback loop manifested itself in my social media feeds, where I often saw the Polymarket or Kashi charts being used by candidates to convince potential voters that they were winning (to get them to jump on the bandwagon) or losing (to get people to give them money).

Political markets are young, attract a subset of participants, and have limited liquidity (though it did improve over the course of the months), and there were clearly times in the weeks leading in to the election, where crowd madness overwhelmed crowd wisdom. On a optimistic note, these markets are not going away, and it is almost certain that there will be more traders in these markets in the next go-around and that some of the frictions will decrease. 

To "crowd" or not to "crowd"

    I am convinced that in making our choices as consumers and citizens, we will be facing the choice between market-based assessments and expert assessment on more and more dimensions of our life. Thus, our weather forecasts may no longer come from meteorologists, but from a weather market where weather traders will tell us what tomorrow's temperature will be or how much snow will be delivered by a snow storm. As we face these choices, there will be two camps about whether market prices should be trusted. One, rooted in the wisdom of markets, will push us to accept more crowd-sourcing and crowd-judgments, and the other, building on market madness, will point to all the things that markets can get wrong. 

    While I do believe that, in balance, the wisdom will offset the madness in most markets, there are places where I will stay wary, as a user of market prices. Put simply, rather than view this as an either/or choice, consider using both a  market pricing, if available, and a professional assessment. In the context of my discipline, which is valuation, I use both market assessment of country default risk, in the form of sovereign CDS spreads, and sovereign ratings, from the ratings agencies. The latter have more knowledge and expertise, but they are also slow to react to changes on the ground, and I am glad that I have market prices to fill in that gap.  If you are planning to trade on these markets, I would hope you will heed my admonition from this post, where I argued that if you are buying or selling something that has no cash flows, you can only trade, not value, it. In the context of political markets, the price that you are paying is a function of probabilities of outcomes and your capacity to make money in the market will come from you being able to assess those probabilities better than the rest of the market. 

    There is another use for these political market securities that you may want to consider. To the extent that you feel emotionally invested in one candidate winning, and you don't have much faith in your probability assessments, you may want to consider buying shares in the other candidate. That way, no matter what the outcome, you will have a partially offsetting benefit; a win for your candidate will make you happy, but you will lose some money on your political market bet, and a loss for your candidate may be emotionally devastating, but you may be able to soothe your pain with a financial windfall.

YouTube Video

Political Market Links

1. Polymarket
2. Kalshi

Book Links

1. Extraordinary Popular Delusions and the Madness of Markets
2. Conclave (Robert Harris)

The Sugar Daddy Effect? Assessing Corporate venture capital, Sovereign funds and Green Energy!

    It is a sign of the times that I spent some time thinking about whether the title of my post would offend some people, as sexist or worse. I briefly considering expanding the title to  "Sugar Daddies and Molasses Mommies", but that just sounds awkward, or even replacing the words with something gender neutral, like "Glucose Guardians", but very quickly passed on the idea, deciding to stay with my initial title. After all, I am too old to care about what other people think, and the type of person who would be offended by the title, is probably not someone that I want reading this post in the first place. The message that I was trying to convey, and “sugar daddy” does it better than the alternatives, is that being dependent on an entity to meet your financial needs will impede your capacity to be self sufficient and will undercut accountability. That was the thought that came to mind, as I was writing about the US government's plans to break up big tech, and chronicling how much the big tech companies have struggled, trying to enter new businesses, notwithstanding the capital and brainpower that they have at their disposal. In keeping with my inability to stay focused, that then led me to also think about sovereign wealth funds, an increasingly powerful presence in both private and public equity markets, and then about green energy, a favored destination for impact investors over the last two decades. What do corporate venture capital (CVC), sovereign wealth funds (SWF) and green investing share in common? They all have had almost unimpeded access to capital, from parent companies (with CVC), the government (with SWF) and impact investors (for green investing), and seem to, at least collectively, punch well below their weight, given their size.  

Corporate Venture Capital

    Corporate venture capital (CVC) refers to capital invested by established firms, into young companies and start-ups, sometimes in the same business and sometimes in others. The motivations for the practice vary,  and the payoff from CVC is debatable, but it is undeniable that CVC is growing as a segment of venture capital, and that it is not only affecting the pricing of the young companies that are targeted, but also altering the economics of venture capital, in the aggregate.

Motives

    To understand why companies turn to investing like venture capitalists, I will bring in my life cycle perspective, with cash available, investment choices and growth potential at each phase:

For most young companies, where the free cash flows from existing businesses are negative, because of shaky profitability and large reinvestment needs, investments are likely to be focused on existing businesses, and venture capital will not be on the menu. As companies mature, with business models delivering profits and reinvestment needs declining, it is not surprising the companies look outward, with acquisitions often entering the equation. For those companies that are able to scale up, with growth, and especially so in businesses where there is uncertainty about how the future will unfold (in terms of markets and technologies), venture capital can become a more attractive alternative to both internal investments or acquisitions, because it allows these companies to spread their bets across multiple plays, hoping to hit it big with a few of them. Seen with this perspective, corporate venture capital investments can be framed in one of two ways:

1. Replacement for internal R&D: For some companies, corporate venture capital investments displace internal R&D, designed to generate future products and develop new technologies. This is, again, more likely to happen as companies age, and their internal R&D loses its punch. Arguably, this is the prime rationale for the growing venture capital arms at pharmaceutical companies, with almost $30 billion invested in biopharma ventures just in 2022.
2. As real options: In businesses where there is substantial uncertainty about how product technologies and markets will evolve over time, companies may decide that investing in young businesses with divergent and sometimes competing technologies will yield a higher likelihood of success than investing in just one, either through internal investments or through an acquisition. In effect, this company is creating a portfolio of options in its CVC holdings, and hoping that big payoffs on the options that pay off will cover the costs of the many options that will expire worthless.

There are two other reasons why companies may play the venture capital role, and they lead to very different choices in that role:

1. Side benefits to core business(es): A company may make venture capital investments in businesses with the intent of using those businesses to augment core business growth and profitability. Thus, while these investments may not generate payoffs to the company as stand-alone investments, they may still create value, if the side benefits are significant. 
2. Stand-alone VC business: In some companies, especially those with slowing core businesses, the corporate venture capital arm can be designed to be a separate business, structured and treated like a stand alone VC business. In this structure, the corporate venture capitalist behaves like regular venture capitalist, with returns measured on finding the right start-ups to invest int and then exiting from their investments, by selling to other venture capitalists, selling the company to an acquirer or taking it public. 

In summary, corporate venture capital is likely to not only be more diverse, across CVC arms, but even within the same CVC arm, investments can be made with different motives. 

    While corporate venture capital may be viewed as a departure from much of the rest of the investments that a company makes, they are seldom structured as independent entities. Put simply, there are relatively few firms, where there is corporate venture capital arm or division, that is in charge of, and accountable for, CVC investments. A survey of companies with corporate venture capital arms in 2021, for instance, found that less than ten percent are set up as standalone legal entities that resemble institutional venture capital.  Many CVC investments are "off the balance sheet", reducing both independence and accountability, but with widely varying capital commitments from the parent company:

• In some companies, a multi-year capital commitment is made to the CVC, allowing it more freedom to make commitments of its own.
• In other companies, the commitments are made on annual basis, reducing the autonomy of the CVC in its own investment decisions
• Finally, there are companies where the capital available to the CVC is residual, reflecting the cash flows to the parent, where individual CVC investments may need corporate approval, reducing independence even further.

In sum, no matter how they are structured, CVCs remain tethered to their parent companies, dependent on them for funding, and affecting what they invest in, and how much.

Magnitude

    Corporate venture capital has existed, in one form or the other, for decades, but it has grown to become a larger part of overall venture capital investment, as can be seen in the graph below, where I look at CVC in aggregate dollar value, and as a percent of overall venture capital investment:

    CVC has grown from less than 25% of overall venture capital investing in 2005 to close to half of all VC investment in 2023. While CVC accounts for a smaller percentage of deals made, it makes up for that by investing in much bigger deals:

Corporate venture capital tends to invest in much bigger companies than the conventional venture capital with an average post-deal value of $500 million in 2023, compared to $210 million for conventional VC. 

    To get a measure of how a CVC arm evolves, I took a look at Google Ventures, Alphabet's CVC arm, and one of the largest and most active corporate venture arms in the world. Founded in 2009, and with Alphabet as its only funder, Google Ventures had over $10 billion in invested, in 2024, in more than 400 technology startups, spread across multiple businesses including healthcare, the life sciences and even financial services. Google Ventures has prided itself on using data-driven algorithms to determine what start-ups to invest in, and when to halt a deal, and being manned by engineers, rather than financiers, though it scaled back the practice in 2022. Over its lifetime, Google Ventures has picked some big winners, including iUber, Airbnb and Slack, all of which are now public companies with substantial market capitalization. Not all corporate venture capital forays have happy endings, though, as was the case with SAP, which shut down its corporate venture arm in 2024, seven years after starting it, because of deal setbacks.

Performance

        Going back to the motives for corporations enter the venture capital game,  you can broadly categorize CVCs into two groups, broadly based upon the benefits they expected from their investments:

1. Financial: In this category are investments made into venture capital, where the returns come directly from the investment, in the form of cash flows or at the time of exit (in a sale or public offering). 
2. Strategic: In this category are venture investments, where the benefits are still financial, but accrue to the parent company in the form of more efficient R&D or as options that pay off, and often more in the long term.

A survey of 257 CVC funds in 2024 yielded the following breakdown of where the payoffs are expected:

SVB CVC Survey in 2024

Note that only 15% of the surveyed funds are purely financial, with the rest broken up into those that claim either a primarily strategic motive or a hybrid (mix of financial and strategic). 

    It is the mixed objectives of CVC that make it difficult to assess how well it has performed on its investments. Thus, while corporate venture capital collectively generate lower returns for their capital providers than tradition venture capitalist, in their defense, they provide benefits that go beyond the VC returns (in cash flows and exit), to the parent company's bottom line (as higher revenues, lower costs and more efficient innovation). The SVB survey of corporate venture capital provides an interesting picture, contrasting how companies backed by CVC differ from traditional VC-backed companies in terms of exit:

Note that fewer CVC-backed companies go out of business, than do VC-based companies, with half the failure rate and more companies advancing to the next round. While this is good news for the funded companies, indicating that CVC funding is more durable and long standing, than traditional VC, it does point to a weakness in the CVC model. VC success comes from finding the right targets, and entering and exiting at the right prices, but it also comes from being ruthless in terms of cutting off companies that do not measure up. To the extent that the data in this table can be generalized to all CVC ventures, that lack of ruthlessness may eat into returns, since weak companies will continue to get funding for longer than they should.

    There is one final test, albeit a flawed one, to examine whether corporate venture capital adds value to the parent company, at least in the aggregate, by looking at stock price and operating performance of companies with CVC programs. In a 2010 study of 61 firms with CVC arms, the researchers concluded that shareholders of the CVC parent companies react negatively to investments made by the CVC, and also that the reaction was less negative with CVCs that were structured as standalone units. That result clearly is not conclusive proof that CVC is value-destructive, since the optionality or side benefits from CVC are both uncertain and may take a long time to manifest. 

Sovereign Funds

    In 1953, Kuwait, seeking to create an investment vehicle for the oil riches that were just starting to emerge, created the very first sovereign wealth fund, i.e., a fund that is funded by the government presumably to protect and advance the interests of its citizens. Since then sovereign wealth funds have multiplied, with a significant percentage still in commodity-rich companies and funded with commodity wealth, but their reach has widened. In the United States, for instance, where the Alaska fund, a funded by the state of Alaska, from oil production, has been the only sovereign fund of any magnitude, both sides of the political divide have started discussing the need for a sovereign fund for the country. 

Motives

    Looking across the sovereign fund universe, it is clear that a significant majority of these funds originate in commodity-rich (mostly oil) countries, and that their funding comes from exploiting their oil reserves. Since oil is a finite resource, and reserves will be emptied out over time, it does make sense for countries with commodity riches to set aside some of these richest, in the good years, and to invest those funds for the long term benefit of their citizens. Thus, the first mission that sovereign fund managers have is a conventional one, shared by all active fund managers, which is to deliver returns on their investments that augment and grow the fund. It is this context that they allocate their funding over multiple asset classes, and within each asset class, pick and choose what to invest in. It is true that there are some differences, even on this money management dimension:

1. Sovereign wealth fund managers control a wider array of the portfolio management process than most traditional fund managers. Thus, they often make both the asset allocation decision, as well as the security (equity, bond, real estate project) selection decision, whereas traditional fund managers often have compartmentalized roles, specializing in a specific asset class. 
2. Sovereign fund managers also operate under a different set of constraints, with some built into their mission statements, that determine what they can invest in, and how much. Thus, a sovereign fund can be required to invest in some businesses and geographies, and barred from investing in others, whereas conventional fund managers often do not face the same constraints.

Sovereign wealth funds face a unique challenge, which is that they have a second mission, which can sometimes be elevated about the fund management mission, which is to serve the national interest, as can be seen in the following examples:

1. Economy building: The Public Investment Fund (PIF), Saudi Arabia's sovereign fund, has been given the mission of delivering on Vision 2030, the Kingdom's ambition plan to wean the Saudi economy away from its dependence on oil. As a consequence, the fund invests a significant proportion of its money in Saudi-based businesses in aviation, defense, entertainment, tourism and sports.
2. Green energy: Given the global angst about climate change, it should come as no surprise that many sovereign funds are required to invest a portion of their portfolios in green energy and  renewables, even if those investments do not carry their economic weight. Norges, the largest sovereign wealth fund in the wold, has a renewable energy component of the fund designed to invest in wind and solar infrastructure.
3. Sector strengthening: In some cases, sovereign wealth funds are given the mission of building or strengthening a domestic sector. The China Investment Corporation lists "maximizing return with acceptable risk tolerance" as a core objective, but also lists that its mission includes recapitalizing "domestic financial institutions as a shareholder abiding by relevant laws in order to maintain and increase the value of state-owned financial assets".

In fact, much of the talk of a US sovereign fund is driven less by conventional fund objectives, since there are plenty of vehicles that investors (individual and sovereign) can use to try to optimize their returns, given their risk appetites, and more by national priorities that are unfunded or underfunded right now.

Magnitude

    The sovereign fund universe has increased dramatically in the twenty first century.  In the graph below, I look at the number of sovereign wealth funds in existence, by year, and the aggregated value of these funds:

The number of sovereign wealth funds approached one hundred, at the end of 2023, and they collectively controlled more than $12 trillion in funding at the time. Asia has the largest number of sovereign wealth funds, but the funds from the Gulf/Middle East are among the largest, in terms of funding at their disposal. In fact, you can see their dominance by looking at the list of largest sovereign wealth funds at the start of 2024:

In 2024, the largest sovereign wealth fund is the Norges, the Norwegian sovereign wealth fund, which was funded with oil wealth from the North Sea oil reserves decades ago. The Asian entrants on this table include three funds that are from China (including the Hong Kong fund) and two longer standing players from Singapore (GIC and Temasek). While the United States does not have a sovereign fund, the state of Alaska has one, funded again by the state’s oil wealth, with benefits accruing to its state residents; the Alaska Permanent Fund, as it is called, paid a dividend of $1,312 to every Alaska resident (with a residency of at least a year) in 2023, and is expected to pay more than $1,700 a resident in 2024.

    These funds have wide latitude on investing, and they invest across asset classes - equities, fixed income and alternatives (which include private equity, real estate, infrastructure, hedge funds and commodities) :

Source: Invesco (2024)

Their investments are in both public and private businesses, as sovereign wealth funds increasingly look for returns in younger companies and businesses that would be targeted by venture capitalists.

    In terms of structure, there is an extraordinary amount of diversity in how these funds are structured, and who controls the levers and evaluates performance. At one extreme are the Norges and the Singapore-based funds, where transparency is par for the course, and the fund managers enjoy a high degree of independence from governments. At the other extreme, the line between sovereign wealth fund and the government is blurred, opacity (about what the fund is investing in, and how well or badly these investments are doing) is the name of the game and there is little or no accountability. Not surprisingly, the latter group is more vulnerable to political pressure and corruption, with some SWFs becoming slush funds and patronage machines for the politicians that they answer to. 

Performance

    The research on active investing suggests that active investing collectively has trouble matching the passive investing returns (from owning index funds), especially after the costs of active investing have been brought into the equation. But how does sovereign wealth fund investing do, relative to passive and other active investing? The answer, at least in the aggregate, is not so well, with equity in the companies targeted by SWFs underperforming the market significantly, with the caveat that performance is much better at transparent SWFs than at opaque ones. Looking at the impact on corporate performance, the results are mixed, with increases in profitability, when the SWF's holdings are less than 2% of outstanding shares, but decreases in profitability and worsening operating performance for larger holdings. In short, if the core mission for sovereign wealth funds is preserving and growing a nation's wealth for its citizens, many of them are falling short, and if it is activism at the investing companies, it is not working.

    That said, there are outliers, and looking at them may provide us some insight into why sovereign wealth funds under or out perform. While many sovereign funds are opaque on performance evaluation, offering little in public on historical performance relative to benchmarks, Norges provides exhaustive documentation of how their active investing has measured up to passive alternatives. Since the fund is invested in different asset classes, let us focus on just the equity investments made by the fund and the comparison that they provide with a benchmark (admittedly of their creation):

As you can see, the fund has outperformed the benchmark, albeit by a very small amount, but given the troubles of active investing, the fact that the alphas are positive is a substantial win. At the other extreme, consider the story of 1MDB, the Malaysian sovereign wealth fund, set up in 2009 with money from an oil joint venture (with PetroSaudi), with the intent of encouraging investment in Malaysia. In the years that followed, hundreds of millions of dollars from the fund was used to fund Hollywood movies and bankroll the lavish lifestyles of connected financiers and politicians, before leading to the jailing of Najib Rezak, Malaysia's prime minister, and a $3.9 billion charge against Goldman Sachs, for the bank's role in the scandal. 

Green Investing

    It is undeniable that climate change has moved up the list of global concerns, and if like me, you followed COP28, the climate change conference, this year, or even read news stories about the weather in your part of the world, the need to reduce our carbon footprint does seem urgent, and there are laws, rules and resources that are being directed towards that end. In fact, if investing were measured on the virtue scale, there is perhaps no more virtuous version than green energy investing, and hundreds of billions have been directed towards it. 

Motives

    Of the three groups that we look at in this post, green investing's motives should be the simplest to disentangle. It is to push the world away from fossil fuels to alternative energies, but that is where the consensus ends. For some players in this space, reducing the carbon footprint and fighting climate change is the core mission, with returns being a constraint rather than an objective. Thus, for foundations and perhaps even some endowment funds, investing green with as little loss in returns as possible becomes the mission statement. Unfortunately, the bulk of green investors want to have their cake and eat it too. Among impact investors, a prime source of funding for green investors, a significant majority of impact investors (close to 64%) want to have their cake (at or above-market returns, given risk) and eat it too (by making an impact). 

With equity investors in the green space, this hoped for payoff takes the form of positive alphas, while directing their money to solar, hydro and wind energy investments, and with green loans and green bonds, the higher returns come from being able to earn higher interest on their lending, given default risk.

Magnitude of Investment

    While the speakers at COP28 have lots of legitimate grievances against governments and markets, including the subsidies that fossil fuel companies have received over their lifetime and the laws that enable fossil fuel energy consumption, one grievance that they cannot have is that not enough money has been spent on developing alternative energy, i.e., energy from everything but fossil fuels. Consider the following graph, that reports investments made in billions of US dollars in fossil fuel and alternative energy sources each year.

Barring 2015, not only has far more been invested in alternative energy than in fossil fuels, but the difference is widening. In the aggregate, close to $15 trillion has been invested in alternative energy, and other than a very small slice that has gone into nuclear and low-emissions fuels, the rest has gone into green (solar, wind and hydro) energy. 

    The money invested in green energy has come from multiple sources. A small part has come from governments, either directly or through sovereign wealth funds. A significant portion has come from impact investors, a catch-all for investments made by foundations, investment funds, family offices, pension funds and corporate investors in the space, with investments of about $2.5 trillion in 2021, and expected to grow to more than $5 trillion by 2026.  Note also that investing in green energy takes both the equity and bond routes, and the green bond market has allowed companies to tap into "lower cost" financing, to facilitate their growth in the alternative energy space. In 2023 alone, $575 billion of green bonds were issued, bringing the size of the green bond market to almost $4 trillion, in the aggregate.

Performance - Financial and Carbon Footprint

    For defenders of green investing, it is good news that that so much money has been directed towards green investing, but that is unfortunately where the good news seems to stop. For the most part,  the payoff from green investing has been surprisingly small, on both the financial and the social dimensions, especially given how much money has gone into it. 

    Let's start with the financial payoff from all of the trillions of dollars that have gone towards making the world greener:

1. Business building: When trillions of dollars are invested in a space, you would expect, at some point in time, that this will lead to companies emerging from the space with business models that can deliver sustained profitability and command large market capitalization. In the green investing space, that has not happened (yet). For instance, the 273 publicly traded companies in the alternative energy space (including almost every aspect of that space), in October 2024, had a collective market capitalization of $506 billion, and they reported aggregated revenues of $117 billion in the most recent twelve months. In contrast, just one fossil fuel company, Exxon Mobil alone had a market capitalization of $532 billion, and revenues of $479 billion. Green investing defenders will argue that it will take time for these companies to mature and deliver profitability, but the clock is ticking and the trend lines do not look promising. 
2. Investor returns: On the other side of the equation, what type of returns are investors in green energy getting from their investments? The answer will depend  on whether you are looking venture capital investors in green energy or public market investors, and also on the time period that you examine. While returns for both groups were robust during portions of the last decade, when investor demand for green investing was high, they have come back to earth, and especially so in the last few years. Here again, your response may be two-fold. The first is that you need patience, for these green energy investments to pay off and deliver profits and returns. The second is that green investing is not about delivering excess returns, but about saving humanity from global warming. I have absolutely no problems with the latter rationale, as long as green funds (both equity and bond) make it clear that they expect to under perform markets, when they seek out capital.

In fact, if your response to the financial impact of green investing being unimpressive is that these investment are saving us from global warming, the numbers are not supportive of the virtue thesis. In the graph below, I look at energy consumption, based on source: 

It is stunning how small an effect  the trillions invested in the space have had on where we get our energy, with fossil fuels accounting for about 81.5% of total energy consumption in 2024, about 5% lower than it was twenty years ago . In fact, much of the gains from solar, hydro and wind energy have been offset by a loss in energy product from nuclear energy, the one alternative energy source where almost no money was invested over the period. It is true that there are parts of the world (Latin America and Europe, for instance) where green energy has made significant inroads, but if global warming is an existential crisis, that is small consolation. For those who argue that shifting to green energy takes time, I have two questions. The first is, unless I misheard what climate change advocates are telling me, time is not an ally and we don't have a luxury of moving slowly. The second relates to economics: if it has cost us five trillion dollars (or more) to reduce our dependence on fossil fuels by 5%, will we go bankrupt trying to reduce it by another 35%?

    There are some who will argue that the money spent on green investing has given rise to innovation and new technologies, but I wonder whether that innovation and those technologies are the ones that we would have invested and developed, without a firehose of capital raining down on green enterprises. There is research starting to percolate through the system that we could have made a much bigger impact on greenhouse emissions by spending our R&D on brown innovations, i.e., innovations that make fossil fuels cleaner-burning and less damaging, than on green innovations, i.e., innovations that explicitly focus on just green energy. More importantly, and as noted earlier, it can be argued that the impact investing definition of alternative energy excluded the one source of energy that has had a track record of making a significant impact on energy consumption, i.e., nuclear energy, and spending a fraction of what was spent on nature's energy sources (solar, wind and hydro) on developing safer ways of delivering nuclear power would have moved the fossil fuel dependence needle by far more. 

    In short, green investing, in the aggregate, has failed in terms of delivering financially (both in terms of business building and delivering returns for investors) and socially (in terms of reducing dependence on fossil fuels).. It is the point that I made in my post on impact investing, where I argued that the prime beneficiaries of the movement have been the consultants, green fund managers, advisors and academics who live in its backwaters.

The Sugar Daddy Syndrome

    Clearly, corporate venture capital, sovereign wealth funds and green investing have very different roots and motives, and have evolved differently, but they do share a common feature. Given how much has been invested in each, they have under delivered, at least collectively, and the vaunted side benefits have been slow to manifest, again with exceptions. I am perhaps overreaching, but here are the reasons as I see them:

1. Assured funding: Each of the three groupings has assured funding, though the degree of assurance and magnitude can vary across individual players. With corporate venture capital, it is the parent company, with sovereign wealth fund, it is the government, and with green investing, it has been impact investors, at least for the last two decades. That assured funding may give them an advantage over their counterparts - VC for CVC, traditional funds for sovereign funds and conventional energy companies for green energy investments- but it does come with a downside. Looking at start-ups and very young companies that manage to make the transition to businesses, one factor that plays a role in focusing attention on building business models is desperation, i.e., the fear that if you do not, you will go out of business. That desperation is lacking in all three groupings highlighted in this post, in many cases. Start-ups and young businesses founded by corporate venture capital may not feel the urgency to create and build business models, if they perceive the capital window at the parent company will stay open. In active money management, a big investing mistake can lead to client flight, but for a sovereign fund, that mistake may quickly be covered by government largesse. Finally, with green investing, one reason that there are so many bad companies and investment funds continue to survive is that they use their virtue at least on the climate change front to attract more capital.
2. Mixed Mission: I noted that for each of the three groups, there is a mixed mission, where, in addition to, and sometimes, instead of, their core missions (start-up to success for CVC, investing alpha for SWF and producing non-fossil-fuel energy at a reasonable price for green investing), they are given other missions. Running any entity, when you have more than one core objective, is always tricky, and it becomes doubly so, when you have two or more objectives, pulling in different directions. 
3. Stakeholder distractions: Every entity has multiple stakeholders, and navigating the conflicting interests to deliver success is difficult to do. With the three groupings highlighted in this section, there is at a stakeholder that is the equivalent of a 600-pound gorilla, and what it wants can often overwhelm every other interest. With CVC, that gorilla is the parent company, and the CVC's performance can reflect decisions made at the parent company level that are too big of a handicap to overcome. With sovereign funds, it is the government, and the people who have oversight of the funds, and to the extent that they call the shots, sometimes with other national interests (protect bad banks from failing by investing in them), sometimes with political end games (hire more workers or not fire workers, just ahead of elections) and sometimes for personal reasons (corruption), the SWF can be left with the residue. With green investing, it may be impact investor skews and biases, and governments, that provide the tax benefits and subsidies, pushing companies into technologies and investments that they would not have otherwise.
4. Non-accountability: As you can see, in our discussion of performance for CVCs, sovereign funds and green investing, under performance can always be excused or explained away by either pointing to other mission objectives or arguing that in the long term, success will show up. Thus, a CVC that underperforms a VC will argue that while its corporate ventures did not meet the mark, the side benefits that accrued to the parent company make up for the underperformance. With sovereign funds, it is convenient to point to the other roles - nation building, sector fixing or social safety net - that they play that may excuse the negative alpha. With green investing, the cloak of planet defender comes in handy, whenever the absence of results (either in financial or social terms) is brought up.

That said, though, there are outliers in each group that seem to thread the needle of competing missions and interests and deliver successful outcomes. Using some of those successes as guide, I would argue that there are four features that these winners share in common.

1. Independence: With CVCs, we reported that very few are set up as stand alone entities, with control, over funding and investing choices. If you are investing significant amounts of money through a corporate venture capital, it may make sense to not only separate the CVC from the rest of the business, but also to let the individuals that you pick to run the CVC make decisions that are not second guessed. In the context of SWF, one reason that Norges has been able to deliver above-benchmark returns is because its executive board  is insulated from government interference. 
2. Transparency: In a related point, many CVCs and SWFs are opaque about their working and holdings, with no good business reasons for secrecy. That makes it easier for them to not only hide inefficiencies but almost impossible to assess performance. That opacity is particularly present with the side-missions that these entities are called on to perform - the actions that protect national interests or strengthen financial institutions, for instance, are open for interpretation. At the best performers, though, transparency is more the norm than the exception, and that transparency extends to almost every aspect of how they operate.
3. Separation of motives: I think it was Marc Andreessen who described a house boat, as neither a very good house nor a very good boat. When entities are asked to deliver different missions, intermingling them in decision making will create bad choices. If the Saudi government does want PIF to deliver both solid risk-adjusted returns on its investments and diversify the Saudi economy, it will be better served to separate PIF into two entities - a fund management entity that invests in the best investments it can find and nation-building arm, whose job it is to make the investments or provide the subsidies that work in delivering that mission. Again, at the best performers, there is more of an an attempt to separate core missions from side missions, with clear guardrails on the latter.
4. Accountability: As things stand, it is difficult to hold the entities that make up each of these groups accountable, and the mixed mission is the primary culprit. By separating the missions, accountability becomes easier, since the core mission part of the company can be assessed using the performance metrics of that core mission, and the side mission on how much the money spent advances movement to the social or side goal. That accountability should be followed up with actions, i.e., a greater willingness to shut down corporate venture capital arms that do not deliver and to convert  under-performing sovereign wealth funds from active to passive. 

I went into this post with a hypothesis that corporate venture capital, sovereign wealth funds and green funds/companies underperform their conventional peers - venture capital for CVC, mutual and pension funds for sovereign wealth funds and energy funds/companies for green investors, and that it is assured funding that creates that effect. Having looked at the data, I have rethought my hypothesis, or at least refined it. 

• It is true that, in the aggregate, that the underperformance hypothesis finds backing, with the median player in the CVC, SWF and green investing but there is wide divergence in performance across the players in each group. 
• The very best in each group (CVC, SWF and green investors) match up well to the top players in the peer groups (VCs, actively managed funds and energy companies), with some using their assured funding as a strength to extend the investment time horizons. 
• The key difference, at least as I see it, is that within each of the funded groups, there is not enough pruning of the worst performers, partly because the funders do not or will not demand accountability and partly because the mixed mission statements allow poor performers an excuse for under performance. In contrast, the worst performers in their peer groups are quickly stripped of their funding and drop out of existence. In 2023, an admittedly bad year for venture capital, 38% of active venture capitalists dropped out of deal making. While active funds don’t have as high a drop-out rate, the amount of capital that they invest is sensitive to how they perform in market. That absence of ruthlessness on the funding level for under-performing CVCs and SWFs can trickle down to the companies they fund, with funding lasting much too long, before the plug is pulled. 

Learning Moments

    While this post was directed at CVCs, SWFs and green funds, there are broader lessons here for a wider class of investments. 

1. Funding always has to have contingencies: When companies, governments or institutions create entities that they commit to fund, that fund commitment has to come with contingencies, where if the entity does not deliver on its promise, the funding will be reduced or even shut off. To the pushback that this will make these entities short term, note that the contingencies that you put in can allow for long time horizons and long term payoffs, but the option of cutting off funding has to be on the table. After all, it is entirely possible that the funder can accomplish what they hoped to, with their under performing entity, with a different pathway.
2. Have a core mission: I sympathize with those who head CVCs and SWFs, when they are faced with a laundry list of what they are expected to deliver, with their funding. Since it is impossible to run an entity, or at least run it well, with multiple missions, you have to prioritize and decide on your core mission. Thus, if you are a sovereign wealth fund, is it your core mission to invest your funding wisely to deliver market-matching or market-beating returns or is it to build a nation’s infrastructure? 
3. Social purpose, but with reality checks: In many cases, entities that have a business purpose are also given a social purpose, and while that is understandable, it can give rise to incentives and actions that lead these entities to fail at both. If there is a social purpose component, as there is in green investing and sovereign wealth funds, it has to be made explicit, with clear measures on how much in economic profits the entity is willing to sacrifice to deliver them. In short, claiming that you can deliver good without sacrifice is delusional, and as I have noted in my posts on ESG and sustainability, it is at the heart of the internal inconsistencies and incoherence that bedevil them.
4. Failure can be a strength: In my writing on corporate life cycle, I noted that survival for the sake of survival or growth for the sake of growth will lead to outcomes that make us all worse off. As noted in the last section, the biggest weakness in the three groups is the unwillingness to euthanize underperforming entities, ensuring that good money will be thrown after bad.

As a final note, I have mixed feelings about a US sovereign fund, even though there seems to be enthusiasm for creating one, on both sides of the political divide. There are investments, especially in infrastructure, where I see a need for it, but I worry about the political interference and whether this is the most efficient way to deliver that end results that are sought by its backers. 

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