To invest or divest? It’s become an existential question for our times as the global effort to tackle the climate emergency increasingly involves an urgent reallocation of financial resources.
As well as being asked by large corporations and governments, it’s a question faced by individual investors and pension holders who are deciding how best to invest their savings. It’s also a question that confronts the fund managers whose job it is to invest and manage investment funds on individual investors’ behalf.
The growth of responsible investing means fund managers increasingly have to factor in a company’s performance against environmental, social and governance (ESG) criteria when deciding whether to invest in a business, or divest from it by selling its shares. For instance, is the company taking sufficient action to reduce its carbon emissions or other types of pollution? Are the workers in its supply chain exploited? Is it doing enough to increase diversity?
These considerations are also becoming more and more closely linked with fund managers’ assessments of a company’s expected financial returns, given the economic risks posed by the climate emergency and other social crises.
However, the decision about whether to invest or divest is far from simple. “You could simply exclude companies based on criteria like their carbon footprint,” explains Paola Binns, head of sterling credit at Royal London Asset Management, part of Royal London Group. “But I would argue that’s not necessarily a very useful thing to do.”
Binns says the question you need to ask yourself is whether it is better to stay invested and engage with the company in order to improve its behaviour, or to sell your stake – which might make your portfolio look better, but deprives you of any ongoing influence.
“We believe it’s very rarely black and white,” she continues. “If we’re talking about a utility that has polluted a waterway, we might assess what went wrong and get an explanation. We could speak to the management of the company and ask what measures they are putting in place to ensure that nothing similar happens in the future. And then we would monitor it to make sure the promised improvements take place.”
Walk away from the company and you can do none of these things. In addition, other investors with fewer environmental or ethical scruples will often be happy to take your place.
Engagement is, in a sense, the carrot. But there is also the question of sticks. And investors are using these too. For instance, if engagement doesn’t deliver the desired improvements on, say, carbon reductions, fund managers may decide to threaten to divest – with all the negative publicity that can entail. Indeed, some experts say that shareholder engagement is more effective with this threat. “Divestment campaigns – along with other efforts, such as political efforts to tax carbon – are crucial,” says Emilio Marti, assistant professor in the Business-Society Management Department at the Rotterdam School of Management. “They create the threats that make fossil fuel companies more open to listening to engaged shareholders.”
Of course, when it comes to deciding whether to engage or divest, there are some companies that are unlikely to ever make the ESG cut. Binns says she has “one or two hard exclusions” – these comprise arms businesses and tobacco companies.
However, her decisions are rarely so clear cut. “They’re never straightforward. The fact that money is diverted into greener projects is very beneficial. But then I have to weigh that into consideration with the fiduciary responsibilities that I have for my clients as well.”
Another issue for fund managers is the need to properly interrogate a company’s climate actions and plans. “I’m all for green projects, but you just have to be worried about greenwashing,” says Binns.
If the thinking behind “in or out” is nuanced on the ethical side, it is also complex on the financial side. Many companies could find themselves excluded on financial grounds, regardless of ethical considerations – for instance, because carbon-intensive operations also expose investors to the financial risk of regulatory clampdowns and future carbon taxes. Indeed, the value of some assets, such as certain coal mines and oil and gas fields, might therefore end up being written off entirely – becoming what investors refer to as “stranded assets”.
Binns works in bonds, which means lending capital to businesses rather than buying shares. “We do systematic research on which areas of the market are lending to where the environment might be a risk to your investments. So your risk of stranded assets, for example, is really important.”
Similar thinking underpinned the Norwegian Sovereign Wealth fund’s 2019 announcement that it would divest from pure play oil exploration companies to shield itself from price falls. It will, however, retain stakes in energy companies such as Shell and BP that have some renewable operations.
Fund managers, such as Royal London Asset Management, often pursue both strategies at once. They might, for example, divest from oil in some of their funds that are aimed at investors who want a totally green portfolio, but retain oil assets in others. This is not a cop-out; more a recognition that there are multiple ways to achieve the same goal. “Rather than exclude companies, we want to ask them how they plan to be better in the future – and then ask ourselves if those plans are credible,” says Binns. “I think you need to take the halo off and be pragmatic – it’s about the direction of travel.”
Additional reporting by Duncan Jefferies
Learn more about responsible investing by heading to Royal London – The Invested Generation
