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Special Report ESG: Carbon Risk, Two tactics are better than one

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Stanford University gave a fillip to the global campaign to divest from fossil fuels when it decided earlier this year to divest from coal companies. 

Since then, other high-profile organisations have divested from fossil-fuel companies, including the Australian National University, which earned a public rebuke from Australia’s prime minister Tony Abbott, who called the move “stupid”. In Scotland, Glasgow University announced a similar decision to divest and, in the US, the high-profile Rockefeller Brothers Fund, fuelled for decades by Rockefeller oil money, followed suit, as have others. Divestment is also being promoted by prominent international figures including UN secretary general Ban Ki-Moon, World Bank president Jim Yong Kim, and the indefatigable Archbishop Desmond Tutu. 

As part of the work that Inflection Point Capital does analysing secular global megatrends, the firm has spent considerable time thinking about the growing impact of both climate change and social media, and it believes that the two megatrends are converging.

On the climate change front, the NGO Carbon Tracker has, virtually single-handedly, stimulated an increasingly vigorous debate about ‘stranded assets’ and ‘unburnable carbon’, which has many institutional investors re-thinking their approaches to fossil-fuel companies. 

Divestment is certainly one possible outcome of those deliberations. As an alternative, a recent spate of ‘low-carbon’, passive indices have started to attract institutional capital from leading European asset owners, including Sweden’s AP4 and France’s ERAFP and FRR. The term ‘portfolio decarbonisation’ has entered the lexicon of institutional investors and is attracting more interest and support by the month. 

On the social media front, the advent and proliferation of smart phones has democratised the internet, making it accessible to people on lower incomes without home computers who otherwise would have had limited access. Smart phones, combined with social platforms such as Facebook and Twitter, mean that ‘millennials’ are permanently connected – and millennials are increasingly concerned about climate change.

Sociological research is also revealing that they are interested in actions, not words. A large proportion of millennials are prepared to boycott or support businesses they care about. They are also likely to purchase from a company that supports a cause they care about, and believe that corporations should create economic value for society by addressing its needs. This has serious implications for institutional investors. 

Lazy instrument

We should expect that as the fossil fuel divestment campaign will continue. We should also expect campaigners to get more sophisticated. We are already seeing evidence that the fossil fuel divestment campaigns are learning from each other and quickly adopting successful tactics.

Finally, we should expect that large asset pools, including pension funds, will become a target for future divestment campaigns. 

Whether responding to climate change, or a range of other social and environmental issues, Inflection Point Capital does not believe that divestment is the way to go. There are simply better, more positive and constructive ways to respond that can make a measurable social and environmental difference while delivering returns consistent with an investor’s objectives. 

Across-the-board divestment is an extremely blunt and lazy instrument. In the case of fossil-fuel companies that are the target of divestment campaigns, divestment simply means a loss of any influence over the company. The shares will promptly be snapped up by another investor. The climate dividend? Zero.

There are two ways that fossil-fuel companies can be influenced – through engagement and through investment decision-making. But it is important to understand that these levers need to be used together, and not separately. The challenge with engagement that is not coupled with the ability to decide whether or not to invest is that companies do not feel any real pressure to change. The same is the case where an asset manager invests in a fossil-fuel company but does not engage. Without engagement, no signal is sent to management as to why the investor has chosen to invest, or not invest, in their company.

We believe the most productive strategy for investors is to start by acknowledging two simple truths: the comprehensive global industrial restructuring necessary to achieve a low-carbon energy economy will not happen overnight; and some of the energy incumbents are better equipped than others to use their massive resources to create solutions, and not merely problems, and divestment ignores those opportunities. 

Wave of activism

Instead, we believe that investors should attempt to identify companies best-placed to respond to megatrends, and which understand that the changing world requires innovation and adaptability, and that this should be complemented with strategic engagement that ensures a signal is sent as to the areas where the companies should focus.

 In the case of fossil-fuel producers, this means investing in companies that understand that low-carbon-intensive energy and renewable energy are going to be an increasingly important part of global energy supply, and which are using their strong balance sheets and low cost of capital to diversify their energy sources.

There is a wave of activism coming that will focus on asset owners. Activists won’t be placated by arguments that an asset owner has an engagement strategy or, for that matter, a climate strategy. They will want to see concrete evidence that an asset owner is approaching climate change thoughtfully and with intelligence, and has an approach that is demonstrably effective in catalysing change. In this regard, investment managers have a critical role to play working collaboratively with their asset owner clients. Their role is no longer simply to invest an asset owner’s funds. They can and should also assist asset owners with strategic advice, including how to communicate with stakeholders on these complex, emerging issues.

Flux and change will define the coming decades. We had better get used to it and learn to innovate and adapt – something we expect the companies we invest in to do as well. In our view, divestment simply doesn’t cut it. Neither, on its own, does engagement. For us, the winning formula is intelligent, forward-looking security selection, reinforced by strategic engagement.

Gordon Noble is a managing director and Matthew Kiernan is CEO at Inflection Point Capital Management

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