Fund managers find responsible investing comes with big risks

October 7, 2013 11:57 am

Fund managers find responsible investing comes with big risks

By Pauline Skypala

Long-term investments to support a low-carbon economy are out of fashion

There is a lot you can do with $34tn, for good or ill. In theory, the $34tn of assets backing the UN’s Principles for Responsible Investment should be invested to take account of environmental, social and governance factors. In practice, it is hard to see what difference the UNPRI is making to the world. On environmental grounds alone, the report from the Intergovernmental Panel on Climate Change suggests investors are either unwilling or unable to push companies they invest in to reduce carbon emissions. Concentrations of greenhouse gases in the atmosphere have risen to levels not seen in “at least the last 800,000 years”, the report says.Another report published last week, by the International Programme on the State of the Ocean, said oceans were in a “critical state” due to acidification, warming and other factors, and called for “urgent remedies to halt ocean degradation”.

Should any of the blame for this be laid at the door of big investors such as pension funds and asset managers? They look after our money, so should look after our interests too, which must include trying to prevent runaway climate change. The problem is, that is often seen as conflicting with a duty to maximise returns.

There is also the question of what action investors can take. At one extreme, they can simply sell their holdings in fossil-fuel related companies, an approach some US institutions have committed to.

That is not an option for most, though. The business risk of stepping away from the herd, and courting underperformance, is too high.

The price to be paid for excluding fossil fuel companies is clear from research * by Robert Shapiro and Nam Pham. This shows that, over the 10 years to June 2011, shares in energy companies produced higher returns than any other asset class for US endowments.

Energy stocks provided an average annual return of 11.5 per cent, compared to 2.7 per cent for all US stocks, 6.1 per cent for global equities, 5.7 per cent for bonds, 10.4 per cent for real estate, 6.6 per cent for commodities and 9.4 per cent for distressed debt.

Past performance is no guide to the future, and some argue energy companies are hugely overvalued, as a large part of their quoted reserves will be unburnable if the target of keeping global warming within 2C is to be met. Until that view is priced in, though, most investors will remain reluctant to divest.

Engagement behind the scenes with company management is the most likely strategy for concerned investors, but persuading fossil fuel companies to forsake the opportunity to drill in the Arctic, forgo tar sand exploitation, or even leave their reserves in the ground, is a tough job. Portfolios are too diversified and shareholdings usually too small for investors to have much influence anyway.

This does not stop campaigners from trying to mobilise investors to act.

For its part, the UNPRI has just launched a new reporting framework under which signatories will have to report publicly on “their progress towards implementing” the six principles. But the framework consists of more than 220 indicators across 12 modules, presenting a danger it will be just another box-ticking exercise.

In another example, the UK-based responsible investment group ShareAction is launching a three-year project called Green Light at the end of October, aiming to “transform UK pension funds into climate-conscious investors”.

This is ambitious, given the failure of all the initiatives to date to make much difference. Louise Rouse, director of engagement at ShareAction, acknowledges that previous initiatives have “not really penetrated”. The issue is too overwhelming, and a lot of pension funds do not see it as a priority, she says.

ShareAction will encourage pension funds to assess the climate risk in their portfolios, engage with companies they hold, consider allocating new money to investments supportive of a low carbon economy, and take a bigger role in creating the right policy environment.

It will be hard to move this issue up the agenda, though. The financial services industry demands short term returns above all else from its investments. Long-term risk-taking of the sort needed to support the move to a low carbon economy is out of fashion.

Investors also argue they can do little without government action. This is a valid point. Policy certainty on renewable energy sources, for example, would aid investment decisions. But investment flows are powerful. They can destabilise countries never mind companies, and help new industries flourish.

Money talks, they say. That $34tn should be shouting from the rooftops.

*The financial returns from oil and natural gas company stocks held by American college and university endowments