Meanwhile, the issue of climate remains a highly charged and complex one for investors. Late last year in New York, the United Nations’ Climate Summit 2014 gathered world leaders to discuss how to “reduce emissions, strengthen climate resilience and mobilize political will” for a global agreement on climate change in 2015. At this event, more than 800 global investors — from religious groups to health-care companies, cities and universities, as well as the heirs to the Rockefeller oil fortune — pledged to withdraw $50 billion from fossil-fuel investments in the next five years.
And yet, the implications of fossil-fuel divestment are not straightforward. Stakeholder pressure often obliges investors to take a position on divestment. Ideally this position aligns with the organization’s beliefs and policies and is supported by a detailed understanding of the pros and cons in terms of portfolio implications.
Some investors are taking their first steps toward addressing fossil-fuel divestment by revisiting or establishing investment beliefs that incorporate and clarify the organization’s approach to long-term and prospective ESG issues like climate change. Others are conducting an analysis of the carbon footprint of their portfolio holdings and then identifying ways to reduce this exposure across the portfolio.
Such exposure-reduction actions might include complete divestment of certain fossil-fuel-heavy or carbon-intensive assets, though it could also involve allocating to active or passive low-carbon strategies in a variety of asset classes and/or engaging with portfolio managers, companies and policymakers.
These practical steps aside, many investors are stymied by the size and complexity of issues like climate change. Lacking specific information on how this issue can impact financial outcomes creates uncertainty, resulting ultimately in inaction. This knowledge gap invites rigorous research to inform concrete action.
In the meantime, three key barriers exist to a greater number of sophisticated and influential asset owners becoming more engaged on ESG issues in general and the climate issue in particular:
Barrier 1: Perception that it will jeopardize returns. There is a persistent and deeply held view by many investors that responsible investing comes at a price. The assumption is that responsible investing is really an optional extra that adds to investment costs rather than the more sophisticated approach to portfolio risk management it has become. This perception was corroborated by a survey conducted at one of Mercer’s 2014 Global Investment Forums, where 300 participating investment organizations were asked about their perception of the key barriers to action preventing investors from addressing climate risk. As shown in the accompanying graphic, concern about jeopardizing returns was the clear front-runner.
Some investors also think responsible investing is just about divestment — removing stocks from the investment universe on non-financial grounds — and many studies show that this particular approach to responsible investing can limit returns, and thus potentially be contrary to fiduciary duty. This perception stems in part from a lack of education or awareness around the many different approaches to responsible investing and the growing body of research that points to a linkage between ESG factors and positive financial outcomes, which leads us to barrier 2.
Barrier 2: Complexity leads to uncertainty which leads to complacency. While many finance professionals might be deeply concerned about environmental issues like climate change, it is difficult to know what it means for investing in practice and what should be done in the short term. Climate change in and of itself is a complex systems topic. The 2014 reports of the Intergovernmental Panel on Climate Change, arguably the most rigorous compilation and assessment of scientific and socio-economic information concerning climate change risk published to date, includes many findings that are potentially salient for investors.
However, it is hard for many investors to make asset allocation decisions without foundational research linking climate change to prospective investment impacts and/or without having a clear process for considering such non-financial issues in their investment processes.
Furthermore, while the overwhelming majority of scientific literature confirms human activity is contributing to climate change, polls have shown that only half of North Americans believe this to be the case. These factors and others impede shareholders and investors from developing a reasonable understanding of the impact of climate change on their investments.
Thus, too often, when investment committees are asked whether they have a strategy or point of view around ESG issues like climate change, they are unable to respond in an informed manner, which leads to barrier No. 3.
Barrier 3: Investors want a clear course of action. Investors are, by nature, action oriented. They want to know how ESG risks and opportunities will manifest and what to do about them. Given the diversity of approaches to socially responsible and ESG investing, it can be difficult to figure out what it all means, and what action should be taken. Mercer has developed a framework for sustainable growth that sets out how investors can approach ESG issues systematically — first by developing clearly articulated investment beliefs on ESG to accompany or sit within standard investment beliefs and then by creating policies reflecting these beliefs, which ultimately drive the integration of ESG factors into portfolio allocation decisions.
