Rethinking ESG: The Key to Unlocking Asymmetric Returns

In the world of finance, the interplay between risk and reward is sacrosanct. It underpins the decisions of investors, shapes the valuation of assets, and guides the allocation of capital. So when Environmental, Social, and Governance (#ESG) #investing entered the mainstream with its focus on mitigating risks, it was bound to spark debate.

One of the most prominent critics of ESG, Prof. Aswath Damodaran, has highlighted an apparent conflict between ESG principles and the risk-reward theory. According to Damodaran, ESG investments prioritize risk mitigation and resilience, effectively capping the potential for high rewards. This critique has stirred controversy, forcing proponents of ESG to grapple with a fundamental question: Can ESG investments deliver outsized returns while staying true to their mission?

The answer lies not in discarding ESG but in reimagining it. After all ESG is not to be treated as a "constraint" but as a framework to guide business strategy.

To appreciate why ESG finds itself at the center of this debate, we must first understand its evolution. What began as a tool for aligning investments with ethical values has grown into a multi-trillion-dollar industry. ESG frameworks are now used to evaluate a company’s performance on environmental stewardship, social responsibility, and governance practices, with the goal of ensuring long-term sustainability.

From mitigating climate risks to promoting diversity, ESG has become a powerful lens for identifying well-managed companies. Yet, critics argue that this very focus on risk minimization leads to diminishing rewards. They see ESG as an approach that prioritizes resilience over growth, stability over disruption. Prof. Aswath Damodaran’s critique touches on the core of this paradox:

Resilience Is Defensive: ESG investments often seek to shield portfolios from risks like climate change, regulatory scrutiny, or reputational damage. While this makes them safer, critics say it also limits their upside potential.

Risk Fuels Innovation: Historically, high returns have been linked to high risks. Investors who bet on transformative technologies or untested markets took significant risks and reaped the rewards. ESG’s emphasis on safety, critics argue, may hinder its ability to drive similar breakthroughs.

So, is ESG destined to remain at odds with the risk-reward theory?

To answer this, let us step back and examine a simple question: Why do risks exist? Risks arise from imbalances—between supply and demand, consumption and regeneration, or innovation and inertia. Traditional ESG frameworks focus on mitigating these imbalances to reduce exposure to risks.

But what if, instead of merely mitigating risks, ESG investments sought to resolve the underlying imbalances themselves?

This is where the paradigm shifts and that's where I introduce the missing piece: Regeneration

Imagine an investment strategy that does not just protect against downside risks but actively transforms them into opportunities for exponential growth. Instead of merely building resilience, it drives systemic change, creating new markets, unlocking innovation, and generating asymmetric returns.

This strategy is not about resilience—it’s about "regeneration".

The distinction between resilience and regeneration is subtle but profound. Resilience is about withstanding shocks and maintaining the status quo. Regeneration is about improving systems, turning risks into opportunities, and creating value where none existed before.

To make this vision a reality, the ESG community must embrace a few key principles:

Redefine Metrics: Move beyond traditional ESG metrics to include regenerative impact—such as net-positive contributions to ecosystems, communities, and economies.

Incentivize Innovation: Encourage investments in transformative technologies and business models that deliver regenerative outcomes.

Educate Stakeholders: Help investors, policymakers, and companies understand the financial and societal benefits of regeneration.

Ensure Accountability: Develop robust frameworks to measure and verify regenerative outcomes, minimizing risks like greenwashing.

As ESG continues to evolve, it faces a critical choice: remain focused on resilience or embrace the transformative potential of regeneration. The latter offers a compelling pathway to address its critics, align with financial theory, and deliver superior returns for investors. By shifting the narrative from risk mitigation to opportunity creation, regeneration positions ESG as a revolutionary force in finance.