Can Capital Markets Save the Planet?

Birth of a new investment belief

There is a responsible investment agreement among Dutch pension plans. Whole portfolios, apart from sovereign bonds, are targeted at climate action. Regulatory requirements aside, climate change has forced a shift in our own investment beliefs that is shaped by adaptive learning.

First, global warming is happening and is approaching an irreversible tipping point. This presents risks and opportunities. Their scale and timelines are hard to predict because there are too many interdependencies. Things will evolve and we shall adapt as companies are exposed to a vastly different world to the one they have known.

Second, as owners of shares in a company, we are not held responsible for its actions. But that does not absolve us of our moral responsibility when its activities cause uncompensated harm to wider society. As ‘universal owners’ we have stakes in thousands of companies, so we are indirectly responsible for their carbon pollution. Divesting our shares does not reduce it.

So, we see stewardship as a powerful tool. It means active engagement on climate and other strategic issues in order to improve the quality of our alpha and beta assets. Using the Global Reporting Initiative Standards, we focus on narrative disclosures that highlight real-life stories of the challenges, actions and outcomes behind the dry numbers in regulatory filings. We are acting as long-term owners of businesses, rather than holders of paper assets.

A Dutch pension plan

The average person doesn’t know what COP26 is

We are starting to show interest in climate risks and the opportunities they present.
We don’t know if markets are yet pricing in climate risks. Oil and gas companies are, in fact, being discounted to varying degrees. But there is skittishness in the market that indicates that investors are unsure. Markets constantly seem to be reframing their views.

Also, thus far, there is inconsistency between those already hit by climate change — via rising sea levels, hurricanes, wildfires, droughts — and those who are not. Until the effects are felt more widely, change will be slow. The change in administration in the US is less important than the effect of the media in shaping public opinion positively towards the Biden agenda and the critical role of COP26. People need to be convinced that these are transformational initiatives that will improve their daily lives.

Encouraging the right behaviors will require carbon taxes and subsidies for renewables. But the overly partisan approach in the US remains a big hurdle. As an endowment, we have a 25-year horizon versus the four years of a presidential term. For their part, regulators operate in a different timeframe depending on who’s in office. You need consistent policy, since price signals are super important. But these are not easy to detect in today’s divisive political environment in the US.

A US university endowment fund

The price discovery process will get fresh signals

Financial markets struggle to price in slow-burn issues that do not grab regular media headlines. The underlying transmission mechanism from climate change to value creation has remained unclear without greater clarity on complex feedback loops involving two mutually reinforcing value drivers. On the public policy side, they cover international actions on carbon pricing, energy standards, subsidies on green energy, and mandatory carbon disclosure within a well defined taxonomy.

On the innovation side, they cover breakthrough advances in the newly emerging fields of renewable energy, hydrogen, energy storage batteries, carbon offsets and carbon capture systems. In market economies, predicting the
pace and timing of technological advances is very hard, such is the diversity of actors and their initiatives now in progress.

We are no longer peering through the mist, however. America rejoining the Paris accord is a game changer. The deliberations at COP26 will face fewer impediments, given the global economic heft of the US The pace of progress may be slow, as too many parties are involved and each has their own vested interests to protect. But the direction of travel will be a lot clearer for innovators and investors alike.

In the meantime, we have been capturing alpha returns by focusing on companies with good and/or rising ESG scores that are overlooked by exclusionary screening that avoids the ‘sinners’ and ignores future ‘winners’. We expect a bigger and faster reallocation of capital towards green projects in private and public markets alike.

A French asset manager