Achieving good ‘Green’ returns

COP26 has again reminded investors that climate change is a key element of the investment landscape. Predictions of environmental, societal and economic harm if global warming is not limited to acceptable levels highlight the consequences of getting this wrong. Yet, despite their protestations, swathes of the asset management industry appear slow in responding and have had little or no effect in reducing the growth in our carbon footprint in recent decades. Actions do not match some fine words.

Furthermore, the related environmental, social and governance (ESG) themes serve only to confuse if not worse, at least in part because there are no standard definitions. Being opaque, they offer little genuine choice to investors. This is one reason why Baron & Grant focuses on the more transparent, measurable and clearly defined remit of ‘Positive Impact/change’, through our Positive Impact portfolio.

Successes and failures

Despite China and India’s last minute change to the agreement, which calls for the ‘phase down’ instead of ‘phase out’ of coal power, the UN climate chief is right to say that the COP26 summit deal is a huge step forward. Positives include the unprecedented inclusion of a coal pledge, over 100 world leaders agreeing to end and reverse deforestation by 2030, the methane agreement, annual progress reports and the increase in aid to climate-vulnerable countries. Alok Sharma, its president, deserves praise for achieving a consensus – helped as it was by the UK’s record in many areas.

However, it is also fair to say that the summit’s overall goal of charting a course to keep climate warming limited to 1.5C by 2100 in order to avoid the worst impacts of climate change is still in the balance. There is more to do if this objective is to be achieved, but at least COP26 has provided more tools to reach that goal. For example, countries are expected to report next year on the progress of their commitments – success or failure when it comes to the necessary incremental steps will be very transparent.

It is therefore a shame that the asset management industry is not responding as robustly. There are, of course, exceptions but concerns abound including the extent of ‘green-washing’ and the lack of clarity regarding accepted accreditations and terminology – particularly when pertaining to the ESG themes.  There are no standard definitions adhered to by fund managers. This allows variance in processes and approach which can make it difficult for investors when selecting investments.

And investors are not alone in seeking clarity. Nick Britton, Head of Intermediary Communications at the Association of Investment Companies (AIC), the investment trust sector’s respected trade body, has recently said of financial advisors: “Our research shows that scepticism around the whole concept of ESG investing is now fairly rare among advisers. However, the fog of jargon and competing metrics and standards is confusing even for those who regard themselves as knowledgeable on the subject.

A less generous interpretation as to this disconnect might be to suggest some industry quarters are using the ESG label as a marketing gimmick to keep the investable universe as large as possible, as they fear divesting would adversely affect performance. Commitments to net-zero many years ahead are unlikely to be overseen by the incumbents who are making the promises today, and so cannot affect any performance bonuses.

Shorter-term incremental targets which are transparent would be more testing, and could be included by boards as part of the wider remuneration package. This is not happening at the moment.  And this disconnect is very obvious when investment chief executives suggest climate risk is investment risk, and yet rank poorly among peers when voting on important climate resolutions.

That climate change does present significant risks for investors, if not adequately contained, should not be in doubt. The National Intelligence Committee (a US Government body) confirmed the obvious in suggesting unacceptable climate change could lead to greater geopolitical conflict as countries take further steps to protect their interests – water and mineral scarcity being two possible catalysts.

Dire UN warnings about food security, including the threats posed by droughts and floods, is a further risk – especially given forecasts regarding global population growth. Extreme weather will also particularly affect more vulnerable countries and their sometimes fragile healthcare systems. The World Health Organisation believes climate change presents a significant – perhaps the most significant – health challenge. Resulting mass migration could also contribute to cross-border conflict.

Quantifying the economic impact of such events is difficult. One pessimistic prediction suggests the global economy could be one-fifth smaller by 2050, while forecasts for some of the more fragile Asian countries are particularly dire. Regional crises, in addition to a general slowing or contraction of global growth, may be one consequence. Investors need to be aware of the heightened risks, both by theme and region.

However, the economic upside of embracing the necessary technologies to better combat climate change should also not be ignored. Many thousands of jobs will continue to be created and many businesses will prosper. Investment trust portfolios look particularly well placed to benefit given their close-ended structure provide the ideal long-term incubator environment needed to best nurture such investments, given the time horizons often required.

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