Five sustainable investment trends to watch
The pandemic, war, persistent environmental degradation, and inequality mean that the role of sustainability in business and investment has never been higher profile. In addition, ESG and sustainable investment found themselves the subject of healthy debate too. Against this backdrop, Lloyd McAllister, Head of sustainable investment at Carmignac outlines five themes that he predicts are likely to dominate the sustainable investment discourse over the next year.
A shift from commitments to delivery
A lack of progress on global emissions reductions will move the climate discussion from long-term targets to delivery and a focus on innovation and technology solutions. Delivery was given a shot in the arm thanks to the Ukraine war highlighting the weakness of energy systems vulnerable to geopolitical risks. Consequently, emphasis will turn to scalable technology that can support the transition and renewables growth will continue to outpace expectations. We expect the rush of long-term emission reduction targets to slow and become caveated with dependencies on regulators setting explicit rules and consumers buying lower emissions products and services, as the reality of delivery becomes clear. We also expect brown-to-green transitions to face greater scrutiny but will ultimately become more accepted as the duration and complexity of the energy transition becomes better understood by asset owners. The uncapped tax incentives within the Inflation Reduction Act in the US will drive faster adoption of clean tech in the US and we expect further regulation and activity from central banks and EU regulators, in particular highlighting the EU’s Carbon Border Adjustment Mechanism.
Why it matters: We expect a shift in expectations from long and medium-term “talking” metrics such as science-based decarbonization targets to a focus on capital and operational expenditure that enables the delivery of these targets. With much green tech still nascent and unproven, financial incentives can provide a catalyst for companies to invest in laggard transition sectors such as cement, steel, aviation, shipping and food. Innovation in climate technologies will provide opportunities for investors looking to align portfolios with the energy transition.
Long tech, short oil won’t cut the mustard
It was easy to appear sustainable in the post-crisis era of easy money which generously rewarded growth. This led to the typical long-tech short-energy portfolio becoming the blueprint for sustainability due to its low level of easily measurable negative externalities such as carbon emissions, alongside positive exposure to cutting-edge technology that was improving people’s lives. We believe this somewhat superficial approach will cease to work going forwards, due to higher asset owner expectations, regulation and a different market environment.
Why it matters: We expect portfolios marketed as having sustainable characteristics to clearly demonstrate what client-alignment, additionality or outcomes they are delivering and the extent to which ESG is considered from a financial and non-financial perspective. In addition, we expect the need to show positive engagement outcomes will become a base requirement, rather than a nice to have.
Evolving expectations of fiduciary duty and materiality
There is a growing shift in defining fiduciary duty from shareholder wealth to shareholder welfare accompanied by the rise of stakeholder capitalism. This means asset owners are increasingly expecting asset managers to consider the concept of double materiality whereby both the consequences of environmental and social issues on a company’s performance, as well as the company’s impact on the environment and society, are both considered material.
Why it matters: We expect clients and regulators to talk about ESG issues that appear less relevant to a company’s valuation in the short term but are material to long-term asset owner decision making.
ESG has been attacked in the US by politicians from both sides of the aisle. For the right, ESG represents a political cabal that is distorting markets and dangerously removing finance from crucial industries such as energy and defence. For the left, ESG is the latest game cooked up by Wall Street to extract higher fees using greenwashing. While the arguments often misrepresent, oversimplify or are overly reductionist, the critique of ESG as it becomes more mainstream will force higher quality approaches and transparency, which we view as positive. While political noise often misrepresents ESG, we expect these arguments will remain a source of news flow, thereby creating confusion for clients. Thus asset managers must be crystal clear regarding their investment philosophy and approach.
Why it matters: We hope that there will be a growing recognition that individual or groups of asset managers have some, but not unlimited ability to deliver system-wide ESG goals and that regulators need to step up.
The resurgence of the de-growth narrative
The two dominant economic theories in sustainability either focus on degrowth or green growth. Green growth believes that it is possible to grow traditional metrics like GDP while reaching acceptable global pollution and living standards. De-growth believes that resource consumption needs to fall to enable society to live within an ecologic ceiling. Throughout 2022 the de-growth narrative became more prominent due to the perceived ineffectiveness of green growth. Unless absolute global pollution begins to trend down, the de-growth narrative will likely begin to slowly permeate into broader economic debate and policymaking. Companies with high exposure to commonly perceived “over-consumption” issues i.e. fast fashion and single-use plastic, can expect to draw increased attention from regulators, consumers and clients.
Why it matters: To date, governments have focused policy on the need for companies to quantify their emissions but wider acceptance of the de-growth theory could result in a more interventionist stance. This could have a profound effect on the long-term financial outlook of the most in-focus sectors.