Climate investing: in or out?

Over the past few weeks, PLSA Chair Richard Butcher has been hosting a number discussions lately on climate investing, During those sessions, one key theme has been repeated throughout.

I’ve been chairing a number of remote roundtable discussions lately on climate investing; as part of the PLSA’s ‘Investing for Good’ project which will conclude this October. At the time of writing we’re five sessions in with seven more to go with room for a few more people if you’re interested.

One of the recurring debates has been whether to be in or out.

Climate change is a systemic risk that, in its extreme forms, will impact on every single business. As such, depending on the extent of the form it eventually takes, it impacts on every one of the portfolios we are responsible for. Quite simply, we cannot afford to ignore it. In fact, if we did it would be a dereliction of our duty.

Climate investing is all about analysing a portfolio or opportunity to identify the long term risk that climate change presents to it. It is exactly the same process you might go through with any other form of risk (‘what are the long term prospects for this business?’ ‘Can this business generate the cash flows it needs?’ ‘What are the long term prospects for this sector of the economy?’).

It is not, inherently, an exclusive process. It is simply about knowing what risks are there, trying to understanding them and their potential impact and deciding whether and if so how to mitigate them. Irrespective of whether you are an ‘ethical’ investor or not, climate investing is simple investment common sense, hence the dereliction of duty if we ignored it.

The in or out debate, is a polarising one and follows the analysis. In its expanded form, the question it asks is ‘if the long term climate related risks inherent in this asset are too great for us, do we (a) disinvest to remove the risk or (b) remain invested but use our powers and influence as an asset owner to reduce it to an acceptable level?’

There is no right answer to this question although there does seem to be a consensus view (so far anyway). More on that in a mo.

If the decision is to stay in, there is an important second line of defence to mitigating the risk. It is the ‘use our powers and influence’ part of the expanded question or, to use its more common moniker, it is stewardship. 

Stewardship can be defined as ’Preserving and enhancing the value of assets with which one has been entrusted‘ and there are a few myths about it.

Stewardship is not just about exercising voting rights on equity investments. Instead it is a process of engagement (which might include voting) alone or with others. At a simple level it is about clearly explaining your objectives and asking the asset managers to behave in a way consistent with them.

Stewardship is not the preserve of large funds. Smaller funds, albeit with less weight of influence but still with influence, can exercise stewardship.

Stewardship is not just about direct investment. It can be exercised indirectly, through the manager of a pooled investment fund, in exactly the same way: clearly explain your objectives and ask the manager to take them, along with the views of their other investors (we have remarkably similar objectives so this isn’t as difficult as you might think), to the asset manager – asking them to behave in a way consistent with them.

Stewardship is not just about equity investment. The process of explaining objectives and asking for consistent behaviour can be done just as easily with bonds, real estate, infrastructure and, well, any other asset type.

Nor is stewardship just about active investment. It has an equal application, arguably with greater imperative, in passive investment.

One of the PLSA’s contribution to this has been to publish a cracking guide, jointly with the Investor Forum; ‘Engaging the engagers’’. At 21 pages long it’s a quick, yet invaluable read.

So, if the decision is to stay in, a stewardship process is vital to mitigating risk.

I mentioned earlier there was a consensus view on the in or out question. I appreciate not everyone will agree with this, in fact, some will take violent exception to it, but the consensus is to stay in. The reasons are multiple and complex and probably best saved for another blog, personally, however, I agree with it. Provided I use my powers of stewardship, I can get the return I need for the savers I’m responsible for and help to make the world a better place.

To take part in one of the remaining roundtable discussions, please email [email protected].