by Fereidoon Sioshansi, Menlo Energy

There is no penalty for being sustainable; rather, the opposite may be true.

For some time now, my newsletter EEnergy Informer has been speculating about the dawn of ethical investing – that is, tangible preference on the part of individual investors and/or professional fund managers to invest in companies which care about sustainability, consider the impact of their operations on the environment and – most important – disclose their potential exposure to climate change.

But of course, what matters most is not what the media think but what investors and fund managers actually do. As everyone knows, in our capitalistic system, money ultimately talks.

In the past several years, when we would ask professional investment managers and financial analysts, the polite response was usually something along the lines of: “Of course, ethical investing is on the rise, but our investors, by and large, are primarily (or solely) focused on the returns and not ready to sacrifice yield to save the environment, at least not yet.”

One analyst pointed out that “The only Amazon investors are concerned about is the one that offers next day delivery.”

But recent developments appear to have changed many minds:

• Devastating wildfires in California, bushfires in Australia and massive forest fires in the Amazon – among other calamities – has made climate change much more pronounced in people’s lives and minds. It is no longer an abstract concept for the future or for tree huggers. It is real and it is increasingly here.
• The pressure on large and small corporations to take climate change seriously is mounting – something that was evident at the World Economic Forum in Davos in late January.
• There is mounting evidence that ethical investing or ESG (environmental, social, and governance) need not be detrimental to the bottom line. In fact, sustainable investing may turn out to be above average and potentially profitable.
• Ironically, the persistent denials of climate skeptics – notably the likes of the US president Donald Trump, Australia’s PM, Scott Morrison and Brazil’s president Jair Bolsonaro – among others appear to have galvanised many across the globe who have come to the conclusion that their political leaders are not the least interested in addressing climate change.

They should vote with their investment portfolios.

BlackRock’s recent decision to consider climate change risk exposure is yet another example of how ethical investing – or whatever you prefer to call it – is likely to take shape especially among the next generation of investors, the so-called Alpha generation, the cohorts of Greta Thunberg and her throngs of supporters. Given a choice, they are unlikely to knowingly invest in fossil fuel companies, period. And as time goes on, they will have plenty of choices.

A Swedish proverb says, “Those who wish to sing always find a song.”

But is there any evidence that ethical investing is in fact in? In search of an answer, we sought the views of James Moore, a partner at Redburn, Europe’s leading independent equity research business.

Redburn’s research is used by many of the world’s biggest investment managers in deciding where to invest and how to manage their massive portfolios. Moore confided that “I first got excited about ESG investing in 2005 when we wrote a big report on the subject at my former firm, Goldman Sachs. At the time we were arguably one of the early commentators to push the idea of ESG and sustainability in research at that point. But then for years no one really cared, and I realised that unless big money – BlackRock, etc. – made the move it would remain a niche market and I would be batting by head against a brick wall.”

“With Trump, Greta and the recent fires I think the turning point when public pressure has fed back into policy making and investment strategy at ‘Big Money’ has finally arrived”, Moore says.

In explaining his own change of mind, Moore said: “With President Trump’s negligent environmental stance ironically shining a spotlight on the importance of sustainable policy, Greta Thunberg’s campaign and the terrible fires of the last year – public acceptance of what the scientists have been saying for decades has finally reached the critical mass, which ‘big money’ can no longer afford to ignore. Until now ‘ethical investing’ has been a niche preserve for those who understandably put the planet before the buck, but it was not particularly helpful for finding investment outperformance. Now that our biggest customers – i.e., the major investment fund managers like BlackRock – can see clearer outperformance from ethical investing and, perhaps more importantly, the risk that their customers in turn may walk away if they don’t change, we have seen a big move to ethical investing in the last six months.”

Outperformance, in the parlance of the investor managers, refers to ESG funds generating higher returns than the market average – see below.

Moore says “This is a very significant change in the investing world. As a sell-side provider to these buy-side customers, I have changed my mind 180 degrees on the importance of adding an ESG aspect to our research.”

As an example of the new mindset, Moore added, “Just today Redburn released a research piece on the cement industry saying it is ‘uninvestable’ given its huge carbon footprint.”

In his letter to investors and CEOs in mid Jan 2020, Laurence Fink, the CEO of BlackRock, pretty much said the same when he wrote:

“Climate change has become a defining factor in companies’ long-term prospects.” Pointing out that “… awareness (about climate risk exposure) is rapidly changing, and I believe we are on the edge of a fundamental reshaping of finance.”

More recently, JPMorgan Chase announced details of its new climate commitments during its annual investor day in New York on 24 Feb. The bank said that it will expand restrictions on and phase out financing for coal mining and coal-fired power as well as stop approving loans for new oil and gas drilling in the Arctic. JPMorgan Chase will also expand clean energy financing while sourcing renewable energy for the company by the end of 2020.

We are encouraged by these developments and expects a fundamental shift towards ethical or sustainable financing in the years ahead. What we have seen to date is the proverbial tip of the iceberg. Much more will follow especially once investors realise that there is no penalty for being sustainable. In fact, the opposite is likely to be the case. And when that reality sinks in – perhaps sooner than many expect – fossil fuels and any business with a heavy carbon footprint will be shunned. The impact may be pervasive.

Fossil fuels, like the internal combustion engine (ICE), have had a good run. But their best days are behind them. As the following article explains, some are trying to get ahead of the game – but the challenge of turning two of the biggest global industries around are truly daunting.

With ESG, you can have your cake and eat it too

ESG (environmental, social, and governance) captures sustainability and is sometimes referred to as ethical or responsible investing.

While the evidence is not totally conclusive – for one thing the definition of ESG is still evolving – several studies suggest that companies with better ESG scores have lower share price volatility and are expected to outperform the market as a whole as the impacts of a changing climate become more pronounced.

Other studies suggest that higher-scoring ESG companies tend to have the characteristics of higher quality businesses, including higher profit margins, more stable returns and less employee turnover. The causation, however, is not entirely clear. Do ESG companies outperform because they are socially and environmentally responsible, do they attract more dedicated staff, are sustainable enterprises more profitable, less volatile/risky, or some combination or none of the above?

What is the evidence for such claims? Barron’s fourth annual ranking of big-cap equity mutual funds that received an “above average” or “high” sustainability rating from Morningstar, shows that ESG funds outperformed comparable funds with lower sustainability ratings.

Barron’s reported that the 189 actively managed funds that met those criteria returned 30% in 2019, just shy of the 31,5% for the S&P 500 index while 41% of the 189 funds beat the S&P 500 – far better than the 29% for big-cap equity funds overall that beat the index, and up from the 39% of sustainable big-cap funds that beat the index last year.

Barron’s points out that this outperformance could be coincidence since sustainability has pushed fund managers into high-quality growth companies. It also notes that the outperformance could be fleeting. What transpired in 2019 is not necessarily guaranteed for the future. But then again, nothing is.

For now, Barron’s headline which read “Mutual Funds That Rank High on Sustainability Are Outperforming the Market” is as good as it gets. It said, “Maybe environmental, social, and governance investing is a sustainable strategy after all.”

Acknowledgement

This article was first published by EEnergy Informer and is republished here with permission.

Send your comments to rogerl@nowmedia.co.za