From my position as a Member of the Investment Committee of a Learned Society which is a registered Charity and committed ethical investor, I have, during the last quarter experienced, witnessed non-sustainable stocks (including fossil fuels and other extraction industries) outperforming most of the sustainable stocks. This bounce is undoubtedly a response to the consumption demands of global manufacturing and construction industry in the slip stream of economic revival following the Covid-19 economic recession.
Ethical investors in the form of Charities, Foundations and other Not-for-Profit Enterprises have historically been at the forefront of ethical investment. This type of investment embraces climate change combating products and services, which have a very strong reliance on investment gains, dividends and interest income.
With exception of grants and donations, many of these institutions have few sources of revenue. Trustees and Investment Committee Members tread a fine line between “God and Mammon”- espousing ethical investment whilst demonstrating an historical reliance on healthy dividends from oil and mining stocks! That stance is becoming more precarious, certainly over the next 20 years, as investment in climate change becomes more complex.
The immediate issues are:
Translating political commitments into practical applications is a hazardous process over the short-term but is exponentially hazardous over a 25-30 year period, globally, regionally and by jurisdiction even where the commitment is supported by treaties, legislation and Memoranda of Understanding. Politics is a fickle beast, and commitments can change and vary, or even be entirely set aside .To that extent, investment can only be managed with a relatively short-term perspective bounded by the scope of current geo-political agreement. Change and variation must be considered a certainty based on historic behaviour.
Moving from the big-picture to issuer-specific considerations, a distinction has to be made between physical and transitional risks. In the physical dimension for example, higher seas can endanger plant and infrastructure or restrict or close transportation routes for goods and human capital. Severe storms and disasters can damage or destroy physical assets, disrupting supply chains and causing second and third order impacts around the world. The pandemic demonstrated this unambiguously: Following decades of focusing on ‘just in time’ procurement strategies, many distributors of finished goods were devastated: The continual focus on efficiency created its own costs in terms of a lack of redundancy and capacity. Firms and investors have focused time taking slack out of the system; and in turn, the system became brittle. Linking all the component elements threads together to assess and ameliorate risk is a complex undertaking: an enterprise may have the bulk of its plants in central Europe, but its supply chain may stretch to Asia, whilst its clients are located in North America.
Transition risks arising from the evolution toward a low-carbon economy are even more complex. Regulations change, including border carbon taxes and cap-and-trade policies which are ostensibly designed to drive up the cost of carbon, but may also cloak protectionist policies. Technology evolves, and new products, production processes or power sources may alter the business equilibrium. If governments don’t act decisively to protect the environment, lawyers will almost certainly likely find a way to do it through liability and litigation.
Timing and good fortune are required. History is littered with examples of technologies which launched too early – electric cars seemed set to become the norm in 1900, but the rise of the internal combustion engine eclipsed them and battery technology took over a century to catch up. Many companies which provide intrinsically beneficial products and services to tackle climate change will come to market. The key question is whether the timing is right with respect to the supporting technologies and infrastructure as well as the complex regulatory environment of climate change.
How effectively can these risks be managed?
My conclusion is straightforward. Ethical investors have to develop an interrogatory style which probes the scale, depth and integrity risk management skills of those who manage their funds. Where risks cannot be managed with sufficient depth, confidence or even experience Ethical Investors need to examine how well they have balanced their ethical duties with their financial duties: a balance between God and Mammon!