We held the second in our ‘elephants in the room’ webinar series on 12th May to debate those large awkward subjects which we would all rather not acknowledge. The subject today was whether the ESG bandwagon was squeezing out other important priorities. As ever, Aoifinn Devitt hosted and the panellists were:
Louise Dudley CFA, Portfolio Manager – Global Equities at Federated Hermes
Sarah Wilson, CEO, Minerva Analytics Ltd
Joel Moreland, Principal Consultant, Social & Environmental Finance
Prof. Andreas Hoepner, PhD, Professor of Operational Risk, Banking & Finance, University College Dublin
Until recently most ESG work has focused on equities rather than debt, because they are better understood by most investors. Yet there is clearly more impact when providing new finance than when trading on a secondary market. We asked the question whether we should be focusing more time on the latter. This elephant produced a clear consensus that denying debt was more effective and investors should indeed spend time and resources there.
We then looked at the problems of nomenclature and definitions, and the dangers of greenwashing and green wishing. We agreed that the alphabet spaghetti was confusing but one panellist made the point that labels, and even tickboxes, helped end-investors understand what they were getting. The problems really comes when ESG buzzwords are used interchangeably and it was noted that a lexicography is being prepared for LGPS investors in particular.
Larger firms have bigger teams and longer data sets because they have been doing it for longer. This gives them an advantage both in the depth of their insights but also in their ability to ‘spin’ stories. Panellists had a number of recommendations for investors in this area; don’t be overpersuaded by relative performance either way; use a standardised RFP on an annual basis so that you can compare different managers; do not be afraid to ask questions; do not fall for marketing promise; focus on facts and outcomes; ask how the managers lead their own lives, and whether they really buy into what they are saying; and ask about their professional development record. One panellist said that in their experience companies who were honest usually dealt with risks better.
As the discussion heated up, a member of the audience commented that mediocre active managers who had lost money to passive were stepping on to the ESG bandwagon. A panellist added that there was a clear difference in behaviour between early signatories to the UN PRI and more recent ones. He cited a major fund manager who signed in 2017 as the turning point. The response from another panellist was that, while 30 years of knowledge could be dangerous, it was good to be re-certified and we needed informed consumers. There was a strong view from all that ESG should not be separate from investment analysis. It should be treated alongside other risks in a risk register, albeit perhaps as the biggest risk today.
We asked whether the net zero targets which are so popular with companies today are going to work. Our panellist started by saying that done well, they are great but it was better to focus on the short term (2025) than the longer term. However, too often they are just a fig-leaf for a company’s shortcomings. It was better to look for investment opportunities – here the problem is much more about scaling ways to move to a zero-carbon world than discovering new solutions. He commented that climate predictions have been more accurate than economic ones, which should make it easier for companies to put in place sustainable business models. He added that the Government’s role should not be neglected here. The regulations and policies they set are going to be as important in catalysing a real change as any behaviour by companies or individuals.
We came on to the initial challenge of this webinar: are we spending too much time on ESG? At one recent fund manager update meeting the ESG analyst had spoken for 45 minutes before the fund manager could get a word in and we asked whether that was the right balance. Our panel was clear that there was a huge need for education among investors and that the amount of regulation coming down the track over the next two years would only exacerbate the problems. One panellist said it was the most she had seen in 35 years and that the new requirements on Climate-Related Financial Disclosures (TCFD) risked being a car-crash if investors did not start planning for them soon.
A member of the audience commented that it is as important to spend the time wisely and another that LGPS funds were responsible for many other vital functions as well as investment, which could not be ignored. However, the general view was that we will need to spend even more time on ESG going forward, particularly to get over the ‘bump’ of education.
Our final pachyderm was whether green credentials have become overvalued. One panellist was of the view that in this area there was no mean reversion, so ‘green’ companies could not become overvalued and ‘brown’ companies were never undervalued. The lack of alternatives has pushed valuations in areas such as renewable energy to high levels in liquid markets. We wondered whether we could really consider them as ‘impact investments now that the demand for renewable energy means they would have gone ahead anyway on financial grounds.
We touched on the failings of ESG scoring and asked the question whether long term modelling could be sufficiently accurate to add any value. It is probably easier in some industries than others, but as an example we noted how ‘dieselgate’ was essentially a tail risk and hard to factor into models. The point was made that greenhouse gas (GHG) emission scoring, unlike financial metrics, did not balance, so scepticism is appropriate, especially where companies have agendas. It is no surprise that credit ratings paid for by companies correlate, whereas GHG ones don’t.
The debate was in full flow when our hour was up and we sorely longed to repair to the bar to continue. Sadly, in the virtual world, that was not possible, but thank you to all our panellists and Aoifinn for her moderating.
Climate Change Expectations for Investee Companies - sets out a manager’s ESG expectations from investee companies
Renewable Energy Environment - paper by Atlas Infrastructure August 2019 looks at trends in renewable energy
Bill Gates – How to Avoid a Climate Disaster – The Solutions We Have And The Breakthroughs We Need – this does not have all the answers but is easily accessible
The Complexity of the E – Osmosis white paper on the lack of correlation between ESG scoring
Regulatory Initiatives Grid - May 2021 - FCA matrix of upcoming regulatory initiatives referred to in the conversation
As a change, we have suggested some people to follow on Linked In rather than more articles.