There is a reason so many discussions about tackling the climate crisis have become discussions about finance and investment. The global effort to avert the most catastrophic effects of global heating is in one sense an emergency mission to reallocate resources and capital. Which means that money – lots of money – plays an essential role.
A fundamental shift has therefore been taking place in the world of investments and pensions. Investors are now paying increasing attention to how companies perform against environmental, social and governance (ESG) criteria. Put simply, it’s about valuing companies against their impact on the planet and people rather than valuing them against their profits and products alone. These ESG factors used to be seen as nice to have. Now they are viewed as essential for large pension and investment funds.
“Increasingly, people are realising that where their money is invested is a really key part of how they can make a positive difference in the world,” says James Alexander, chief executive of the UK Sustainable Investment and Finance Association (UKSIF).
James Clarke, a senior fund manager at Royal London Asset Management, notes that clients now invariably raise these issues. “For me, it’s been a really fascinating transition and it is one that keeps accelerating,” he says. “If you take ESG themes like climate, three years ago nobody was really asking about them. Now, they’re part of every single meeting I go into.”
So what has happened? How has investing suddenly become not just a force for good, but often a key driver of corporate action on the climate crisis? In a financial sector that has, in the past, had a bad reputation for short-termism and for putting profits ahead of everything else, the shift is all the more surprising.
Clarke says the factors behind this shift are multidimensional and take in everything from the mainstreaming of climate as a public concern to a changing regulatory environment, to the way companies look at risk. He also points out that the debate has largely moved on from: “Is there a problem?,” to: “What are the best ways to solve this problem?”
It is a complicated issue. Fund managers are not social entrepreneurs. They exist to make a return for their investors – and there are plenty of green and socially useful technologies where the risk-return ratio just isn’t right for the people whose money they’re investing. There is also the question of what a “good” company is? The world of responsible investing throws up many complex grey areas, which can make the analysis and expertise of fund managers so important.
For instance, take electric vehicles. They are better for the environment, but some of the raw materials needed to make them, such as cobalt, are mined in hazardous conditions, sometimes involving child labour. Furthermore, you also need to think quite laterally. In terms of reducing carbon emissions, a videoconferencing business might be a better bet than an electric car company even though the latter appears more obviously green.
There are also questions around the impact of divesting (when a fund sells its investment in a particular company or sector) from companies that are less green – again highlighting how things are rarely clear cut when it comes to responsible investing. “If you just sell your assets at this stage in the game, you’re probably going to sell them to someone who cares less than you do,” says Alexander. “We don’t really see divestment as a key route to achieving a stable future. Rather, we prefer responsible stewardship and engagement.”
Selling out of companies such as fossil fuel businesses can have real downsides. If you drive their share price down to the point where they get taken over by a private equity firm, they are often simply run in the most cash-generative way possible, away from public scrutiny – and this rarely means taking a long-term, sustainable view.
A recent dramatic example of how activist investors can force change in companies by engaging took place earlier this year when Engine No 1, a small hedge fund that factors ESG into its investment strategy, shocked the energy world when it got three of its nominees elected to ExxonMobil’s company board. This was widely seen as a warning to the company, both over its failure to take climate change seriously and its recent poor returns.
Complicated though a lot of the detail of this may be, the business case is actually quite straightforward. Put simply, climate change is a huge investment risk. Companies that look good from an ESG point of view tend to have a more long-term and fuller view of their business. This takes in numerous factors, ranging from a lower risk of public boycotts and climate-related insurance premium hikes to problems related to regulatory changes and even the ability to attract better staff.
The clear-and-present investment risk of companies that aren’t taking sufficient action on climate change has also collapsed the long-held assumption that a trade-off exists between profits and the planet. The interests of shareholders and wider society are becoming increasingly aligned.
“It’s about all of us becoming aware and engaging.” says Clarke. “We all need to be part of the solution and this puts pressure on the businesses that we deal with, to clean up their act.”
Learn more about responsible investing by heading to Royal London – The Invested Generation
