What sustainable investing means for asset owners
Everything is changing, sometimes slowly and sometimes very fast
“How did you go bankrupt?” Bill asked. “Two ways,” Mike said. “Gradually, then suddenly.” Ernest Hemingway's - The Sun Also Rises,
Everything is changing
It’s becoming increasingly apparent that the climate transitions are going to fundamentally alter what makes a good investment. What is less appreciated is that the transitions are also going to dramatically change the role that asset owners need to take in the investment process. Just to be clear, by asset owners we mean the providers of investment capital – insurance companies, pension funds, endowments, family offices and HNWI’s plus retail investors
Which requires a different way of thinking about asset allocation
The future we see is a greater involvement in the investment identification process (answering the question -where do we want our money to be allocated) and in engagement (how we want the leverage our investment gives us to be used). Both of these will require asset owners to be better informed about the likely direction of travel for the various climate related transitions. The Bigger Picture blogs are our contribution to this process. At its core is the belief that better informed asset owners and investors can make better and more meaningful climate related investment decisions.
Start at the beginning, not half way through the process
One of the things you may have noticed about a lot of discussions around investing in the climate transitions is that they often start in the wrong place, at the end of the process, with the companies or funds. Surely a better place to start is at the beginning, with the problem we are seeking to fix. From there we can explore where the barriers to implementing possible solutions come from, specifically are they technology related, or are they instead political/social or regulatory. Then, how will the transition develop over time, and perhaps most importantly, when will it become financially viable. This takes us logically to where we should be allocating our capital, both to deliver the transitions we want, and to optimise our financial returns.
Understanding the why enables us to spot greenwashing better
It seems to us that skipping this part of the discussion leaves investors less able to spot green washing (or putting it more bluntly – non solutions) and green wishing (wanting a solution that involves no pain so much that we suspend critical evaluation). Our belief is that the better the climate related transitions are understood, the more meaningful our investments can be, and the less likely we are to end up following dead ends, fads or bubbles.
Yes, its tough, but they are your values after all
One of the pushbacks to this view that we often get is that “this is all very well but investing in the climate change transitions is incredibly complex. In fact, it’s so complex that I can never know enough to make the “right” decisions. So, its best if I leave this to my asset managers, and then I can use the company or fund ESG score to keep a track of where they are investing.” We think this approach, while understandable, is just plain wrong on many levels.
And ESG scoring is just a start
To start, ESG scoring, while really useful in terms of aligning investment portfolios with values, is only part of the solution (often a small part) when it comes to fixing our climate transition challenges. Take reducing green house gas emissions. One part of the current solution is to get publicly listed Oil & Gas companies to stop future exploration (to reduce their own green house gas emissions and improve their ESG score). Yes, this is a constructive thing to do, especially if it aligns with your investing values and objectives. But, the bigger long term contribution is going to come from supporting those companies that are building the goods and services of the future, the ones that will make future oil and gas use redundant. So, renewables, grid stability, electric vehicles, and the electrification of our homes.
And sustainable investing is not just about value alignment
In addition, ESG scoring on its own misses a really important point, sustainable investing must still have at its core the concept of a fair financial return. Which means continuing to consider risk and reward and thinking about issues such as “as the world changes, can this company continue to cover its cost of capital, and if so, how long can it do this for”.
Aligned incentives and structures are very important
On top of this, we need to think much more deeply about the incentives and structures inherent in how we select, monitor, and manage the intermediaries/asset managers who invest our money. This is about much more than just alignment of interest, although ensuring both sides have the same perspective as to what makes a good investment for you is a good start. It’s also about engagement. This was challenging enough when it was just about financial risk and return. True engagement in that world was time consuming and expensive. Now we need to overlay sustainability. There are many perspectives on what to engage on & how to do it successfully (including the divestment debate). The reality, in our view, is that engagement is becoming so complex that it needs to be a partnership between the asset owner and their agents, the asset managers and their consultants.
You have to be your own expert
This may seem counter intuitive, after all one of the purposes of having specialists such as asset managers is that they become experts in their fields. That worked fine when the expertise was about something that was measurable ie “finding the best investment” (ignoring for a moment the active vs passive debate). Looking forward there are going to be a whole range of much more subtle decisions, where determining success or failure of an engagements process is much harder.
We need more of a partnership and less outsourcing
We argue that putting together all of these factors, avoiding greenwashing/greenwishing and a different style of engagement, you conclude that asset owners and their asset managers need more of a partnership approach. For this to work, we need asset managers to be better informed about the various climate transition debates. This takes us back to our starting point …. better informed asset owners and investors can make better and more meaningful climate related investment decisions.
Finally, and very importantly, nothing in this blog should be construed as providing investment advice. For company and/or fund specific investing advice and recommendations, you need to look elsewhere. In more formal language, this blog does not constitute Investment Research as defined in COBS 12.2.17 of the FCA’s Handbook of Rules and Guidance (“FCA Rules”). See the end of this blog for links to important information and disclaimers.