The landscape of climate-friendly investments has shifted hugely since I wrote my first blog on the subject 2 years ago.
2021 was a record year for ESG, with an estimated $120 billion poured into sustainable investments, more than double the $51 billion of 2020. Some of this could be self-fulfilling, with Blackrock switching up it’s model portfolios to include their sustainable funds.
In private markets, venture capital investment in climate is growing steadily, with climate start-ups raising over $32 billion in the first three quarters 2021, easily surpassing $21 billion in 2020.
Meanwhile, 220 asset managers with $57.4 trillion in assets have now signed the Net Zero Asset Managers initiative, committing to supporting the goal of net zero emissions by 2050 or sooner. There’s also the Net-Zero Banking Alliance (NZBA), Glasgow Financial Alliance for Net Zero (GFANZ), the Net-Zero Insurance Alliance, and Net-Zero Asset Owner Alliance in case you can’t keep track…
Historically impact investing and ESG was seen as having a cost to pay for an investors ethical predilections. Over the last decade the evidence base for ESG outperformance has grown.
There are suggestions though that recent out-performance perhaps has little to do with ESG, and in fact is just quality factor investing in disguise, with outperformance disappearing when adjusted for risk, sector bias and quality factors.
ESG stocks performed well through the start of the pandemic, but pulled back in 2021, with oil & gas outperforming.
Time will tell!
Transparency & clarity
It’s worth noting here that investing in ESG does not necessarily mean you’re funding the clean energy transition. The AIC has called for product labels that distinguish between a focus on environmental sustainability and those targeting positive social change, though it would be possible for a single fund to carry both labels if it met the standards.
The EU has implemented the Sustainable Finance Disclosure Regulation (SFDR) aiming to make the sustainability profile of funds more comparable and better understood for retail investors – albeit key tranches now have been delayed again until July 2022. Perhaps this will start to force ratings providers and the fund managers to be far more transparent over which companies are considered for an index, and why they are included or excluded – anything will be an improvement on the current woefully opaque state of affairs.
Another key part of the puzzle will be improving the quality of the financial disclosures of companies, so these can be better assessed, so it’s been good to see the IFRS publishing prototype international climate sustainability reporting requirements, which Forbes labelled the biggest change in corporate reporting since the 1930s.
Beyond the lack of transparency, there’s also far more active greenwashing within the ESG ‘goldrush’. 55% of climate-focused funds are misaligned with global climate targets. Meanwhile the signatories to the Net Zero Asset Managers initiative are in fact on-track to cut their CO2 footprint by just 20% this decade, falling far short of what is needed, whilst continuing to bid for and fund fossil-fuel assets.
MSCI’s ratings, the largest provider of ESG ratings, have almost nothing to do with the environmental and social impact companies in the fund have on the world – instead, they measure the potential harm government regulations and other factors might cause to the companies’ bottom line, especially when it relates to addressing climate change.
For instance, Bloomberg found that only one of 155 ESG upgrades of S&P 500 companies cited an actual cut in emissions as a factor.
Regulators are slowly beginning to catch up to this flurry of activity – the UK regulator has now published guidance on what it expects to see from funds describing themselves as sustainable or ESG. Notably, funds need to “demonstrate to investors how well a fund is meeting its stated ESG/sustainability objectives”.
The regulators are not in the clear themselves here either. The EU recently proposing labelling gas as climate-friendly – something perhaps surprisingly even investor groups are arguing against. Without a doubt there will continue to be some political football alongside nuclear energy until this is resolved.
ESG as a distraction?
Vanguard’s ESG funds represent 0.1% of its total assets under management while about 94% of new money is flowing into Vanguard’s mainstream non-ESG funds. Meanwhile they have lent over $7.6 billion to coal companies, with $3.6 billion of those bonds set to be refinanced over the next ten years. Blackrock has made progress (from a low base) on this front, but continues to facilitate Adani opening up a new coal basin.
Diversity & Climate justice
Progress on diversity and inclusion is moving incredibly slowly, or even backwards – in 2021, 1.1% of European capital raised overall went to all-women founding teams, and 8.8% to mixed-gender founding teams.
And on the public markets, while some are starting to invest more broadly when it comes to ESG, there’s a definite risk that emerging economies are left behind unless significant progress on ESG are made – raising questions over the level of progress that is actually fair to expect, when developed economies have benefited from decades of ‘dirty’ growth.
A separate mention should go to the EU’s emission trading system, which hit record prices in December this year. There’s some pretty big challenges, amongst which are ensuring that carbon offset schemes are deployed appropriately (as a last, rather than first resort), and contribute to genuinely reducing carbon in the atmosphere that would not have been removed or abated otherwise.
Does any of this make a difference?
For all of this progress, complexity and greenwashing – there remains the question, does any of this even do any good and have any material impact on achieving our net zero goals? Does divestment work? How can we best direct capital to where it’s most impactful? Well… stay tuned for part 2.