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Daniel Wild, Bank J. Safra Sarasin

Daniel Wild, Bank J. Safra Sarasin

By Elisa Trovato

Asset management has a key role to play in the transition to a greener economy

Recent extreme, record-breaking weather events have proved another harsh wake-up call for investors and society at large on the dire consequences of the climate crisis.

Natural disasters including droughts, heat waves, fires and floods devastated communities around the world in 2022. In Pakistan alone, an extraordinary monsoon season killed more than 1,700 people, displacing 33m and costing around $40bn in property damage. Such tragedies could become the ‘new normal’ if greenhouse gas emissions are not rapidly reduced, scientists warn. 

While substantial support is needed by policy-makers and change must occur across both the real economy and society, private capital, led by the asset and wealth management industry, has a key role in financing the transition to ‘net zero’. The question that needs to be asked is: how much can the phenomenal growth of environmental, social and governance (ESG) strategies do to slow the advance of human-driven global warming? 

ESG-labelled assets are forecast to pass $50tn by 2025 and represent one-third of projected total global assets under management, according to Bloomberg Intelligence. Many of these funds currently employ exclusionary approaches, avoiding carbon-intensive sectors, such as energy and utilities. So ‘decarbonising’ portfolios does little to reduce emissions in the real world. 

Most ESG funds tend to hold firms that pollute less and have better social conduct, compared with non-sustainable strategies, which helps them mitigate sustainability risks and potentially enhance performance. Whether they can drive impact is, however, more questionable.

 “Despite such significant growth in ESG assets in recent years, their actions, for many of them, don’t actually result in progress or improvement on any real-world environmental or social measures,” states Andrew Lee, global head of sustainable and impact investing for UBS Global Wealth Management’s chief investment office. 

A recently updated academic paper by the European Corporate Governance Institute, which examined US socially responsible investment funds (SRI) for almost a decade, shows SRI strategies do not improve environmental and social outcomes of investee companies, despite the majority claiming to actively engage with portfolio companies with the intention of generating impact.

Driving change

The global economy is significantly behind schedule on achieving net zero – a key sustainability objective – by 2050. To meet climate targets, trillions of dollars need to be spent to decarbonise energy, replace myriad industrial processes with clean alternatives, improve energy efficiency and transform infrastructure.

“The asset management industry plays a critical role in accelerating transition to a clean, green and sustainable economy,” says Amit Bouri, CEO and co-founder of the Global Impact Investing Network (GIIN). “We have seen heavy emphasis on exclusionary approaches, and decarbonisation of the economy, but we also need to accelerate investments into climate impact investments.” 

Investors, urges Mr Bouri, should direct capital to investments that explicitly aim to drive positive, measurable real-world change, combined with financial returns. 

Impact investing, a term first coined by the Rockefeller Foundation in 2007, has surged of late, with total worldwide assets passing $1tn late last year, according to the GIIN. Impact investors achieve objectives through a range of mechanisms. These include: supplying capital to underinvested areas; focused engagement strategies encouraging credible transition at public companies; and venture and growth equity funds backing private companies providing innovative solutions to sustainability challenges, like decarbonisation of the urban environment. 

Positive climate investments cut across the entire economy, and include clean and green energy, from large scale renewables to clean energy access, such as household solar panels in rural areas of developing economies, says Mr Bouri. 

While the energy transition is essential, investment is needed to green other industries too and includes tech-based investments, ranging from housing technologies for sustainable building materials to green fintech. 

“Investors are looking for areas of growth, for the ‘green shoots’ of the future economy. And that’s where climate impact investment will be critical,” he says, expecting these innovative investments to meet both their financial and impact goals.

Countries’ determination to become independent of Russia’s energy sources, because of Moscow’s aggression against Ukraine, has accelerated the transition to renewable energy creating new investment opportunities. “Investments in solar and wind power, as well as battery storage and other technologies to develop renewable energy, have represented the greatest opportunities for investors over the past year,” says LGT Private Banking’s head of sustainable investing Chris Greenwald. 

Investment in renewable and clean energy is spurred by western policy-makers’ strong capital commitments toward sustainable goals. US President Biden’s Inflation Reduction Act of 2022 earmarked $369bn for climate investments. The EU responded with the launch of its €400bn Green Deal Industrial Plan in February, following last year’s €300bn REPowerEU.

In addition to greenfield renewable energy, impact investment opportunities are found in energy storage infrastructure, scalable greentech, alternative materials, agricultural technology, energy efficiency and circular economy solutions, amongst others.

The role of nature

Nature-based investment solutions are also vital in mitigating the climate crisis. “Nature is a huge carbon ‘sink’ and essentially fulfils this role for free,” says Federated Hermes’ head of investment Eoin Murray. 

In fact, more than 40 per cent of carbon dioxide equivalent emissions are soaked up on land and by the oceans. This is underappreciated and a reason we must protect and restore habitats and ecosystems and stop biodiversity loss, adds Mr Murray, pointing to fruitless attempts to sequester carbon with technology so far. “If our natural sinks continue to decline, climate change is likely to accelerate and get worse, so maintaining healthy forests, peatlands, soil and oceans is crucial.”

With adaptation to the climate crisis becoming critical, infrastructure companies that help make coastal areas more resilient to storms and flooding, or companies providing environmental and design consulting, also look appealing.

But filling the green investment gap will not be possible without the participation of carbon-intensive industries, including traditional energy, materials and industrials, all essential to the global economy. Engagement with companies in these sectors has the potential to drive change toward sustainable and impactful sourcing and production practices. 

An estimated $100tn investment will be required to ‘green’ the world’s capital stock over the next 30 years. Of this, more than 50 per cent must be allocated to energy and utilities sectors to reach the 2050 climate targets, according to BNY Mellon Investment Management. These two sectors face the largest climate transition challenges, but also a high probability of incurring stranded assets. 

BNY research forecasts a potential $20tn worth of stranded assets during the transition, namely assets that must be scrapped or retrofitted, simply because they will have reached the end of their economically useful life during the next 30 years.

More than half the investments needed are expected to be in emerging markets, a quarter of this in China alone. “Engagement allows for the directing of capital to sectors and geographies that need it most. This is where the biggest transition opportunities for investors lie,” says Kristina Church, global head of responsible strategy at BNY Mellon Investment Management, finding value in companies with “credible transition plans”. She believes “divestment should be a very last resort, should a company fail to transition”.

But to generate the most effective impact in public markets, active strategies must be designed around “explicit, theory of change driven engagement approaches, focused on real-world change,” suggests Mr Lee at UBS. 

These strategies must go “well beyond” broad stewardship and encouragement to improve disclosure, emphasising “proactive and collaborative engagement against a set of defined outcomes, together with regular management and measurement of progress toward these goals”.

These comments are in stark contrast with investors’ sentiment in the current energy crisis. In 2022, the six largest Western oil companies made more than $200bn in profits, higher than in any year in the history of the industry, largely from pumping and selling fossil fuels. And those companies best positioned to boost output, reducing their commitment to the energy transition, were most rewarded by investors. 

“While fossil fuel investments strongly outperformed in 2022, it is important investors do not overreact in the short term,” says Bank J. Safra Sarasin’s chief sustainability officer Daniel Wild. He urges investors to focus on the most promising long-term solutions in light of the energy transition, such as renewable power generation, power grid enhancement, energy efficiency and storage solutions. Some of the possible other solutions to the current power supply gap, such as new nuclear power, have lead times of up to 20 years to be operational, he explains. 

But the question is whether these new energy sources will still be competitive in two decades. “It pays for investors to anticipate how the future energy infrastructure will look like, rather than jump to short-term conclusions.”

It may take decades to fix the climate emergency, but smart investors had better start investing with impact now, both for their own benefit, and the benefit of the planet and broader society.  

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