Activists target French company TotalEnergies for its environmental policies and involvement in Russia. Photo / Bloomberg
OPINION:
Responsible investing, and in particular the way in which environmental factors are taken into account, is in the midst of a storm.
Environmental, social, and governance (ESG) restrictions have been blamed for contributing to high energy prices, while investors with ESG mandates have also missed out on some of this year's best share price returns — which have come from energy companies.
The reaction of some large global investment managers to the energy crunch and Ukraine war has also led to criticism of the industry's commitment to the climate change challenge.
So what gives? Why bother with ESG at all?
ESG will remain a critical feature for investment managers in the future. However, what the current storm does highlight is the importance of investment managers recognising real-world complexity in their approach to ESG. Simplistic exclusion policies and headline-grabbing slogans are going to be found wanting.
Engaging with companies is important. Debating and making calls on complex issues is important, even if there are divergent views among investment firms of the "right" answers.
ESG policies relating to fossil fuel energy producers have become more restrictive. Twenty years ago, it was the norm for institutional investors to invest in oil and gas producers. In recent years we've seen large institutional investors divest from oil and gas and place a range of limits on investments in the energy sector.
Regulation has also followed this trend. In 2020 in New Zealand, the Government required default KiwiSaver providers to exclude a range of fossil fuel producers from investment.
Underlying these decisions is the idea the world needs to move to decarbonised energy sources over time. Implicit in these fossil-fuel exclusions is an encouragement for energy companies to innovate and develop clean energy sources.
Balanced against this is also an acknowledgement that moving to clean energy will take time. Until then, we need fossil fuels and related infrastructure to tide us over.
However, there is criticism that the investment industry and governments around the world have swung the pendulum too hard in favour of the environment. That two other e-words — energy and the economy — have been neglected.
There is an equation of sorts among these three e-words that needs to be kept in balance. If this gets out of kilter, the world comes unstuck. And that is what we're seeing with the spike in energy prices.
Last year, green activists forced major oil producers Chevron and Shell to cut their carbon emissions substantially over the coming years.
Shareholders also successfully installed two directors committed to driving a greener strategy on ExxonMobil's board.
This sort of activity has affected the amount and geographic location of fossil fuel exploration in the past decade. It has led to underinvestment in fossil fuel exploration, especially in stable geographies.
It has inadvertently made the world more reliant on fossil fuel energy from countries with poor social and governance track records. Countries like Russia and Venezuela.
The three e-words got out of kilter, and all that was needed was a match to light the fire.
Russia provided the match when it invaded Ukraine this year. The world has been grappling with higher energy prices ever since.
This has sparked fierce debate within the investment management industry on how to respond to this situation.
A survey of investors by research house Bernstein found that only 15 per cent of respondents said they would increase their exposure to fossil fuel and nuclear due to the conflict in Ukraine.
The majority, 85 per cent, said they would not change their ESG policies. For now, it would seem that investment managers are standing firm with their current settings.
However, there have been notable exceptions. Blackrock is one of the world's largest fund managers, long a proponent of climate-friendly investment policies.
Due to Ukraine and energy price spikes, Blackrock has done a U-turn on aspects of its climate change agenda. It says it will vote against green shareholder activism this year.
Large global investment manager Vanguard also said in May that it would not end new commitments to fossil fuel projects despite its determination to safeguard its clients from climate risks.
Cynics could argue that Blackrock's change of tack shows a lack of commitment to climate change. Fossil fuel producers have been some of the best performing companies on global stock markets this year.
So perhaps Blackrock is looking for a way to justify investing in a hot sector of the market. On the other hand, perhaps it feels its policies were in the right direction, but went too far.
If so, Blackrock should be commended for changing tack. Pursuing a policy you no longer believe to be fit for purpose clearly makes no sense.
This shows how hard it is to strike a balance when grappling with climate change.
Encouraging clean energy innovation has to be set against the acknowledgement that the transition will take time. Fossil fuels are with us for a while.
Responsible investing needs to reflect real-world complexity — It is not an exact science Energy seems to be taking primacy over the other two e-words at the moment.
However, the climate change challenge is not disappearing. With each tonne of carbon emitted into the atmosphere, the problem gets worse.
It would be remiss of fund managers to sit on their hands and bequeath what could become a very large problem to future generations.
The squeeze in energy prices highlights the importance of speeding the development of technologies that help the world decarbonise.
Government policy and institutional investment policies play a vital role in making this happen.
To be effective, fund managers need to be principled and thoughtful in framing ESG investment policies.
Relying simply on blunt ESG scores as a means of assessing the impact of companies on the environment won't suffice. Focusing on carbon intensity metrics in isolation won't suffice.
In the Bernstein survey, 30 per cent of respondents said they were open-minded about and more receptive to investing in ESG improvers.
Improvers are companies tangibly making an effort to lift their ESG standards. So, for example, if a fossil fuel producer reinvests profits in clean energy innovation, should it be treated in the same way as one that pays out those profits in dividends?
What is the difference in the long-term strategies of firms that all get bucketed together by blanket exclusion policies? Should these differences be recognised when setting ESG investment restrictions?
At a minimum, engaging with companies will be important. Understanding the context of companies' decision-making and why they behave the way they do will also matter.
The debate about how to calibrate ESG policies to strike a necessary balance between competing objectives is only just beginning!
- Robbie Urquhart is senior portfolio manager, Australian equities, at Fisher Funds.
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