The responsible investor: a key player in the transition to a green economy
Interested in contributing to the transition to the green economy? With your investment decisions, you can play a leading role.
Whether investing in a fund or a separately managed account, individual investors can have a real impact on the economy and the shift to a more sustainable society. One of the main challenges in this transition involves addressing a massive reduction of our dependence on fossil fuels.
To help to reduce this dependence, individual investors may use one or more of the four main sustainable investment strategies, each with their own strengths and challenges. The four main strategies are: 1) exclusion of fossil fuels or divestment from fossil fuels, 2) shareholder engagement on fossil fuel-related issues, 3) investing in companies that are the best in their sector on social and environmental issues, and 4) impact investing, or intentionally investing in renewable energies and efficiencies with measurable impacts. These strategies are not mutually exclusive. In fact, many investors will want to use some combination of all of these strategies.
Exclusion or divestment
The strategy of excluding fossil fuels, or divestment from fossil fuels, is essentially a statement of an awareness of the negative impacts of fossil fuels on the environment, the climate and the potential for human life on earth and aims to send a clear message to companies, policy makers and the financial market (see United Nations position). Among the biggest worldwide initiatives, the Fossil Free movement, the Divest-Invest coalition and Keep it in the Ground, from the Guardian.
But beyond environmental concerns, the question of fossil fuels has also become a real issue of financial risks. Indeed, investments in fossil fuels are now considered by many to be more risky (see HSBC report), especially because of the “carbon bubble” (see explanation below), which threatens a significant loss of the value of securities held in the fossil fuel industry. For many individual investors, divesting from, or avoiding the sector can be justified not only on moral grounds, but also on long-term financial grounds.
The Carbon Bubble
To keep global warming below the 2 ° C threshold and meet the carbon budget (maximum level of GHG emissions) prepared by the Intergovernmental Panel on Climate Change (IPCC), three quarters of world reserves of fossil fuels must remain in the soil (EIA, 2012). To date, however, the value of the securities of firms operating in this sector is set according to their ability to extract these reserves. Thus, if action to combat climate change continues to intensify and governments legislate to maintain those reserves in the ground, then it is likely that the shares held in these companies would be vulnerable to devaluation (the popping of the “carbon bubble”).
While it may send a clear message, the strategy of exclusion of, or disinvestment from, the fossil fuel sector still has significant challenges, and the desired outcomes – including the impact on stock prices – are not always tangible. In addition, when an investor excludes a company from its portfolio, the investor loses any influence it could have on the company to bring about change.
The engagement strategy is seen as a way to influence corporate behavior through share ownership. It is done through dialogue with the companies held in the portfolio, submission of proposals for all shareholders to vote on, and exercising shareholder (or “proxy“) voting rights. The engagement strategy can also involve engaging public authorities.
This strategy offers the opportunity to encourage companies held in the portfolio to disclose certain information, allowing the investor to measure and incorporate the carbon risks in the investment analysis and management. Engagement can also be used to bring these companies to improve their objectives and do so not only in terms of climate change policies (transparency, risk management, GHG reduction targets, etc.) but also on a number of other environmental issues as well as social and governance issues.
The engagement strategy also comes with its challenges. Among them, the feeling that it is compromising for private investors to hold securities of companies involved in controversial areas. Note also that even with sustained pressure, it is very difficult to change the nature of a company’s activities, especially when most of them are still driven by performance requirements and short-term profitability.
Impact investment and “Best in Class”
The best-in-class strategy and especially the impact investment strategy also allow the investor to contribute to the transition to a greener and more sustainable economy.
We will present the advantages and challenges of these strategies in another post. Until then, we invite you to visit our website where you will find much relevant information.