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Long Term Matters: Climate Change

I have been amazed about the stubbornness of two well-informed groups who disagree fiercely with each other but who do agree (in practice at least) on one thing.

The divestment advocates are genuinely concerned about climate change – many have made significant changes to reduce their own carbon footprint – and are passionate about investors taking action.

And there are traditional investment professionals who, as individuals, accept climate science but act in a professional capacity as if they do not.

So what do the two groups agree on?  Both, in practice, say no to forceful stewardship. Their arguments are different – the traditional investors rely more on technical and legal nit-picking while the divestors say they are already doing the best they can.

To put it mildly, I have been a bit perplexed by both. Then, one day I was chatting with my Preventable Surprises colleagues and a light went on. The conversation was triggered by a US renewable energy advocate who said: “The basic problem is that the financial system is heavily invested in the status quo. Too rapid a shift leaves huge stranded assets – not just oil reserves in the ground, but factories built last year to manufacture equipment and goods that will no longer be needed. Such a sudden write-down of the capital asset base would be devastating.”

This commentator is right about the problem: portfolios are exposed to the wrong assets, and it is much more than just the fossil fuel allocation. But he does not see how stewardship, not stock-picking, is the way forward.  

The conclusion he comes to is, unsurprisingly, disempowering and incrementalist – exactly how the investment community deals with climate risk.

My reaction provoked my colleague, Bill Baue to say: “I wonder if our field – either consciously or unconsciously – realises that the underpinnings of their entire portfolios are fossil fuel-based, and if they consciously or unconsciously resist the enormity of the task of applying such thinking to their entire portfolio.”

And it is at this point I realised that divestors and traditionalists are, in one respect at least, quite similar.

Traditionalists ‘know’ they cannot influence systemic risk and so ignore it or try to make money from climate change. While much is implied about the wider benefits of portfolio decarbonisation or green funds/climate bonds, the reality is that these are strategies for maximising risk-adjusted portfolio returns relative to peers. They are not primarily strategies for managing systemic risk.

Divestors also ‘know’ they cannot address the enormity of the problem, and so have found an enemy to punish in the fossil fuel sector or the investors who make money from this sector. The practical consequence is that they, too, are relieved of responsibility for doing other things.

But if investors act together they can influence systemic risk. Investors are as close to a magic bullet as we are likely to get, more practical than geo-engineering and less dangerous. Investors influence market dysfunctionality and systemic risk all the time, generally exacerbating risk.

That leaves us with a question: who is more likely to lead the investment industry? Will it be divestors – who are well informed on climate but emotionally wedded to divestment – or traditional investors who operate as if scientific illiteracy could be the basis for sound investments which, as Ashby Monk notes, is “individually rational but collectively crazy”?

Dr Raj Thamotheram is co-chair of Preventable Surprises and a visiting fellow at the Smith School, Oxford University

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