We assess how companies and individuals can be truly sustainable in our modern world.
*Investors should consider asking their investment managers what being sustainable means to them.
*For some companies, ESG still remains a ‘box-ticking’ exercise with little focus on corporate strategy.
*Being truly sustainable means making personal sacrifices.
*Governments need to buy in to sustainable change and also need to incentivize companies and individuals.
An old colleague once asked me a profound question: how has being involved in sustainable investing actually changed your life? Beyond the flippant response that it has made me fashionable for the first time ever, it does make you think about how the sustainability imperative gets played out – not only in clients’ portfolios, but in daily life. It is also a good question for fund selectors to ask investment managers, so they can test their credentials when it comes to sustainable investing.
More Than a Box-Ticking Exercise
For me, the journey into sustainability started well over a decade ago through a reintroduction to the science of climate change. As a former mathematician, it immediately reawakened my ‘inner nerd’ via talk of complex, interactive and unstable systems subject to phase changes. I was also struck by the public caution of the climate scientists that I met versus their much more pessimistic private views; a decade on and the latter perspective has proven to be the more accurate one. That led me to think about the implications for investment performance and risk management in a world in transition, and how it related to other factors influencing financial returns. Working for a firm with a high profile in responsible investment was also an advantage, but beyond the power of corporate engagement, I often felt that environmental, social and governance (ESG) investing was in danger of becoming too much of a ‘tick-box’ or labelling exercise and not focused enough on business strategy and capital allocation. But what in my life has changed?
Notwithstanding the current coronavirus-related lockdown that has all but grounded the world’s airline fleets, I wish I could say that I fly less, but the demand for sustainability has had me on an airplane more than is good for the planet or my health; we do fully offset in an attempt to compensate. More practically, I have insulated the house, installed better windows, planted trees and left some of our garden to go wild. We recycle like crazy, pick up litter, use more sustainable brands, eat far less meat, look to buy locally sourced and seasonal food wherever possible, as well as having the inevitable reusable coffee cup and water bottle – I now worry about how many of these are being given out at ESG-related conferences. I own an electric vehicle; after driving one, the internal combustion engine seems so nineteenth century. On my gardening leave before joining Newton, I even eschewed the usual travel frenzy to instead decompress and to actually enjoy our garden for three months.
Anyone who knows me will be aware of the special status that my gorgeous chocolate Labrador, Rosie, has in my life; the photograph will tell you why. Rosie and her little friend Maggie are avowed meat eaters and there lies the nub of the problem: their personal carbon footprint is awful. But what of offsetting factors? Not the carbon credits that I might buy to offset their meat habit, such as I do when I fly, but the joy that they bring? This got me thinking more deeply about sustainability in general and the role of incentives in tackling the challenge.
Sustainability Needs to Be Embedded at All Levels
It is easy to change your consumption habits when there is a direct benefit or little cost: the electric car is great to drive, the house is warmer after the insulation went in, the sustainable cleaning products only cost a little more to buy, and vegetarian food can taste good. Where we all struggle is when there is a cost – real or perceived – to changing our lifestyles. For example, if we wanted to reverse the obesity crisis we could simply adopt the diet plan from the Second World War that led to the healthiest generation ever in the UK. Highly effective, but hardly an approach that many would willingly accept as a palatable alternative to their rich and varied diet. As for getting rid of Rosie, that is simply not happening.
For those of us looking for the system change needed to ensure that our lives on this planet have a net-zero impact – we are all in negative territory at the moment – this is an important issue to grapple with. In the affluent developed world, there is an expectation of a style and quality of life to which we are collectively wedded. If we want to maintain our current standard of living – generally defined by what we consume –there needs to be a dramatic change in the way the services and goods are created, delivered and conceived. Sustainability needs to be embedded in every aspect of our lives – personal and corporate – if we are to achieve the demanding goals needed to deliver a healthy ecosystem for all. This is why sustainability is not just about products and services that provide solutions to our environmental and social challenges: it has to form the foundation of how we live our lives and manage our businesses too; rather like we have seen in the current pandemic, there is no royal ‘we’ here, as all of society is it in together: individuals, companies, regulators and governments.
In 2019, Earth Overshoot Day was on July 29, the earliest ever, and marked the date in the year when we used more from nature than the planet can renew in the entire year. Over the last two hundred years we have been adept at pushing the boundaries of human ingenuity to ensure that the nineteenth century Malthusian prophecy of running out of resources has not come to pass, yet this is coming at an accelerating environmental cost. With another two billion people forecast to be added to the global population by 2050, how long can we push environmental limits without dire consequences? We cannot condemn people in the developing world to lower standards of living than ours, as aspiration to betterment is a cornerstone of human nature. These are not the problems of a distant point in time, but are of the here and now.
Alone, individuals and companies are unlikely to be able to achieve the scale of change that is required, nor can they achieve it in isolation from wider civil society if the governance structures that dominate policy decisions provide the wrong incentives. Governments may promote zero-carbon targets for times way beyond the horizon of the current administrations, but remain wedded to an economic model based on the maximization of growth. Worse, some governments are happy to play a game of ‘sustainability arbitrage’ by letting others push ahead with positive environmental policies while doing nothing themselves in order to gain a myopic economic advantage. System change requires vision that is sadly at variance with the tactical policy decisions seen in many of our democracies. For corporations, the incentive structures can hamper the best intentions of the most virtuous CEO, even leading to bankruptcy if poorly conceived.
Central bankers, too, are rightly getting involved with the climate change debate because of the systemic risks it poses to the financial system, yet monetary policy is based on lowering interest rates to coercive levels to spur demand over savings to increase the current pace of growth. The notion of quality over quantity of growth is firmly rejected despite ‘virtue signaling’ by many of our leaders.
ESG, green and sustainable investing alone will not halt climate change, despite the powerful signal that they send. In fact, we need to be careful not to over-claim the benefits because of potential harmful rebound effects. Decarbonizing a public equity fund, for example, by removing all fossil-fuel and utility holdings might lead to a much lower carbon footprint than a reference index, but every other company left in the portfolio is a direct or indirect customer of those carbon producers that are excluded. On some measures, Scope 3 emissions – those that indirectly come from our activities – account for 90% of total emissions and remain critical to the decarbonization of portfolios and society.
Omitting oil, gas and coal companies from a global equity portfolio has been a sound financial judgement over the five years to the end of 2019, as energy was the only sector to produce a negative total return over that period; rising regulation and changing consumer preferences could well make this a secular trend. A weak oil price and declining returns on capital have taken their toll on the sector, yet in that period demand for oil and gas has risen steadily and is forecast to continuing rising over the course for this decade, notwithstanding the current unprecedented but temporary fall in demand owing to the global lockdown in many countries. Over time, increasingly competitively priced alternative energy is likely to accelerate the decarbonization of energy, but will currently not remove oil and gas from our economies at the pace needed to achieve a 1.5 Celsius (2.7 degrees Fahrenheit) world, as it is so embedded in our daily lives. The near halving of the oil price in the last 12 months adds another unhelpful incentive for its continued use, although there is temporary respite as much transport is currently inactive owing to the pandemic.
Even if bond holders – a more powerful force in changing company behavior than shareholders – stop financing the large publicly listed energy majors and drive them out of business, it would be naïve to believe that the productive assets will lie idle if there is demand for the product. Pushing ownership of oil and gas assets into murky and unaccountable private hands could even lead to worse environmental and social outcomes, as we have seen in many coal-mining communities, now and in the past.
A way to address that problem would be by the insurance industry denying insurance cover to environmentally destructive activities, something that is beginning to happen in coal mining. Extending this to senior executives’ insurance cover would focus minds within fossil-fuel companies where there is a growing threat of litigation; there’s nothing like personal liability to sharpen the mind.
To achieve a ‘just transition’ requires a seismic shift in attitudes across society that recognizes the shared value we have in the well-being of the planet. The rise of sustainable investing over the last few years is a powerful signal for change that is increasingly echoed in corporate boardrooms and through the vocal protests especially of the younger generation. The missing element is decisive change in the leadership of our civil society. Companies and individuals alone will not be able to effect the change needed, and green businesses might even become victims of change if economic incentives reward poor behavior. Mark Carney, the recently departed governor of the Bank of England, refers to the “tragedy of the horizon”, which is equally well-directed at politicians often more interested in remaining in power than shaping the long-term health of the planet.
Without the necessary incentives and disincentives that governments can provide through visionary leadership, the efforts of the private sector, no matter how innovative, will ultimately be futile if we continue to see maximization of growth as the virility symbol of economic success. While society is increasingly demanding a shift to a more sustainable system, the market won’t value it if consumption habits across the economy don’t reflect their beliefs. Shared value is not just a concept for boardrooms to integrate, but is also for cabinet offices in the seats of government. The generation younger than those in power seem to get this concept, but let us hope that the leaders of today do not leave them with a system that continues to reward cynicism over the benefits of shared value.
Any reference to a specific security, country or sector should not be construed as a recommendation to buy or sell this security, country or sector. Please note that strategy holdings and positioning are subject to change without notice.
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