In May, the global campaign to divest from companies that profit from the dirtiest of our fossil fuels reached a potential tipping point.
Norway announced that its giant sovereign fund would divest from companies whose business relies more than 30% on coal. It joined an increasing roster of prestigious investors, including the insurer Axa, the Rockefeller Brothers Fund, Stanford University and the Church of England (whose archbishop used to be an oil executive). Pope Francis has also joined the fray, addressing his recent papal encyclical on climate change to all – not just his own flock.
What gives? It has long been the prevailing wisdom that financial interest is financial interest, and ESG* is ESG, and never the twain shall meet. A requirement to prioritise financial interest limited the extent to which ESG perspective could be incorporated, relegating ESG to the status of fringe activity. But the twain have collided on the topic of carbon footprint and ‘stranded assets’ – those carbon assets that are at risk of sudden and unexpected write-downs because they can never be put to use. The killer statistic reported by the Carbon Tracker Initiative is that up to 80% of carbon assets (coal, oil and gas reserves) cannot be burned if we are to achieve our ambitions to curb global warming. These assets therefore risk becoming all but worthless.
As described in my colleague Bob Collie’s recent blog, it is perhaps better to think of ESG issues as ‘future financial’ rather than non-financial. That is to say that they are issues that can have a financial impact in the future, but they are not being fully priced into markets right now. But at some point the future must become the present, and this is what is happening with respect to carbon. 2015 may well mark the moment when the markets began to take carbon risk seriously.
The divestment campaign can surely take some credit for that, but in truth divestment is a pretty blunt instrument. Indeed, many would point out that engagement strategies may in the long run be more constructive. In this article for the Guardian newspaper, the Wellcome Trust set out the case for engagement. And while it is increasingly recognised that financial interest and ESG issues (such as carbon footprint) can coincide, it remains the duty of fiduciaries to preserve financial interest. Divestment won’t always get the balance right – over all but one of the ten calendar year periods ending in the last decade, for example, the oil sector has significantly outperformed the rest of the market.
The slump in commodity prices has meant that the sector underperformed over the last few years and over the ten years to the end of 2014, but a policy of disinvestment would have been financially uncomfortable for much of the last 20 years.
So a more balanced approach may be necessary, capturing the ESG issues without compromising the ability to achieve your desired financial outcome. This means translating the rhetoric into a real portfolio of financial assets designed to target a financial outcome – here’s a case study of that process in action. As the case study shows, and we so often find, it’s the implementation that matters.
Sorca Kelly-Scholte, managing director, client strategies and research, EMEA, Russell Investments