Avoid avoidance strategies to really help change the world

Investors need to provide capital and support to companies in the process of transition

As focus on humanity’s responsibility in ensuring a sustainable future grows, regulators and customers are putting more and more pressure on institutional investors to focus on sustainable investing.
A lot of positive coverage is given to companies and industries considered to be green or sustainable already, as you’d expect. But, we would like to make the case particularly for institutional investors to continue investing in and engaging with companies and industries that would likely not be considered environmentally friendly or sustainable based on common (superficial) screens today. These companies are involved in economic activities that remain vital for continuing economic development, including reduction of poverty and improvement of living standards worldwide.
The problem with a pure avoidance strategy is two-fold. Firstly, by avoiding such companies, we leave the ownership and therefore governance of these companies to other investors who may not care about sustainability issues to the same extent as responsible financial institutions do. Secondly, by limiting the capital available to companies in industries that face sustainability and transition risks, we actually increase the effective cost of capital to these companies, thus limiting their ability to improve their practices or transition to more sustainable business models.
To be clear, this would not mean indiscriminate investment in all companies facing sustainability challenges, but rather selectively providing capital and support to those in the process of transition, helping them to accelerate this process and make the necessary changes. Companies that are unable or unwilling to adapt to the new environment or acknowledge sustainability as a major business factor will not be an attractive long-term investment and would therefore remain off the investment list.
The EU estimates that investments of €180bn per year from now until 2030 are necessary to achieve its energy and climate targets. Much of this money needs to be invested in existing real estate stock, transportation and transmission infrastructure and improving the re-usability/recyclability of manufactured goods. A significant share must also be invested in switching from fossil fuel to renewable energy resources. Accessing this volume of investment capital will require the active participation of regulated investors. Policymakers understand this, and are increasingly likely to use regulation to steer investments in order to achieve sustainability targets that the EU has set for itself.
Given the amount of investment capital managed by regulated institutions, their investment strategies are key to promoting changes at companies and other economic actors. Dealing with large-scale sustainability problems requires involving and working with those who are creating and contributing to them, both operationally and financially.For example, when we talk about climate change, there are several industries that account for the vast majority of green-house gas emissions. If we want to reduce CO2 output across the world, avoiding the energy, utility and transportation sectors will not help us reach our goal, as they continue to play critical roles in the economy yet are responsible for a significant share of CO2 emissions. Without addressing their carbon footprint, we will not be able to halve our GHG emissions.

“Changing the world is going to require a lot of capital.”

Another issue worth exploring is how we assess companies that, on one hand, have a large carbon footprint of operations, yet, on the other, provide solutions to reduce GHG emissions by other industries and companies. An easy example comes from the building materials sectors, where energy savings and GHG emissions reduced by applying quality building insulation and glazing solutions far outstrips the energy costs and emissions generated in their production. A superficial exclusionary approach based on the carbon footprint/intensity of these businesses without taking into account the positive impact of their products and solutions could easily lead to their removal from ‘clean’ or ‘green’ portfolios; yet, without their products and solutions, achievement of climate objectives would be even more difficult than it already is.
If institutional investors, policymakers and regulators are genuinely committed to improving the sustainability of our entire economy, then they must focus on active engagement with companies that can make a positive difference. Without the ability to vote at annual meetings or engage with management, investors’ voices will not be heard at all, and companies will be influenced by stakeholders for whom sustainability may not be a primary concern. This is likely to make current problems even more persistent.
Improving the world’s sustainability requires level-headed investment in and engagement with all economic actors, not just those that already have positive sustainability profiles. Policy efforts to improve the sustainability of investments need to understand and acknowledge this, as changing the world is going to require a lot of capital. Without large regulated investors such as insurance companies, banks and pension funds actively involved in promoting the changes necessary in existing business models, it is unlikely that the biggest contributors to the world’s sustainability issues will be able to adapt as quickly as they need to make a difference.

Eugenia Jackson is Global Head of ESG Research of Allianz Global Investors, and Karl Happe is CIO of Insurance-related Strategies.