July’s ousting of HSBC Asset Management’s former head of responsible investment, Stuart Kirk, on account of comments he made during a presentation entitled “why investors need not worry about climate risk” has shone yet another spotlight on an important issue for ESG investors considering the climate impact of potential investments. At a Financial Times conference in May, Kirk pointed out that because investor time horizons are mismatched with the financial effects of climate change, the process of ESG investing is ill-suited to addressing climate change and mitigating its future impacts.
He correctly pointed out that for most companies with stranded assets, valuations do not take into account anything after 20 years and that, subsequently, climate risks to investors have been overstated by ESG advocates and central banks. The accusation is that central bankers and policymakers have overstated financial risks of climate change in an attempt, and that mainstream sustainable finance suffers from an overdose of groupthink when it comes to correctly assessing the financial impact of climate risk.
Having been involved in sustainable investing for a number of years, I am sympathetic to Kirk’s comments. Discerning investors must be able to separate groupthink and noise from sound warnings about the climate risk of potential investment opportunities.
So how can they do this? Writing in the FT this month, Kirk suggests that ESG must be split in two: one approach which takes environmental, social and governance issues into account when trying to assess risk-adjusted returns on an asset, another which is simply trying to invest in ethical assets. As Kirk argues, one looks at the individual E, S and G inputs as part of the investment process, the other looks at goals to maximise. That way, investors can determine whether funds are pursuing an ESG approach which looks in detail at how individual factors affect the rate of return – a process which requires deep qualitative and quantitative analysis, or whether they are simply looking at potential investment opportunities from an ethical standpoint.
It’s true that there should be a distinction. Many companies which score highly on ESG metrics from an input perspective might not stand up to scrutiny from an output perspective. Yet it is confusing for potential retail investors who are not the ones taking time to understand the detail, but are simply keen to put their money to work in ways which do not damage the planet.
My view is that individual ESG investment managers should determine their understanding of environmental social and governance factors and, as far as possible, set out their investment philosophy clearly to explain how they pick and choose potential targets. That way, there is no confusion between the various meanings of ESG and investors can understand from the outset how their money is being put to work. It should be a part of the fund’s mission statement, just as any organisation would include when operating in a field which means different things to different people.
The Nick Maughan Foundation, a not-for-profit foundation that I run alongside Maughan Capital, is based on a three pillar philosophy – we back causes that further the betterment of education, the environment and the community. That way, anybody who follows its operations knows exactly what causes it supports and why – they all fall under the umbrella of the overriding philosophy. ESG investment funds should work in the same way, with managers explaining their conception of ESG from the outset and making sure their investment decisions stick to it religiously – allowing investors to understand where their money is going and why.
With a field as broad and as complex as ESG, there are bound to be multiple interpretations and views on what it actually means – just as Kirk rightly points out. That’s fine though, so long as there is general agreement that that is the case, and that it’s up to professionals to pick their own interpretation and explain it accordingly. Ultimately, as the regulatory and economic landscape evolves, the field of ESG investing will change too – but there should always be room for different opinions, approaches and philosophies which broadly concur in trying to make investment decisions which are for the benefit of the planet.