Environmental disruption plays out as a transition in governmental, company and consumer attitudes to issues such as climate change, use of water and recycling of materials such as plastics. These issues are more relevant than ever for investors. The Intergovernmental Panel on Climate Change (IPCC) has warned about the dire consequences of climate change and the European Union and the US have set out the many billions needed to achieve the 2 degrees of warming by 2050 from 2010 targets, agreed in Paris 2015 by World Leaders and reinforced at COP24 in December 2018. Not only is significant capital required to achieve these targets, there are significant costs associated with addressing the current impacts of climate change. Indeed, the EU estimates that around €520-€575bn are needed in annual energy and infrastructure investments to achieve a net-zero greenhouse gas economy; while natural disasters caused a record €283bn in economic damages in 2017. Asset managers are only one part of the value chain in these forces of change, as the vehicle for the asset owners’ interests, and are restricted by the solutions and data offered by companies. As a result, Invesco has examined the opinions of fund selectors and FTSE 350 companies in the UK on the materiality and disclosure of environmental disruption, amongst other disruptive forces.
In terms of materiality of the impact on business risks, the greatest difference of opinion was in relation to environmental disruption. Around 40% of FTSE 350 companies believe that environmental disruption would be significant in the next ten years, while fund selectors do not see this trend as material. As investors, this is important context to understand when engaging with companies and asset owners on the topic of environmental disruption.
Despite questioning the materiality of environmental disruption, more than one third of fund selectors argue that it is important for fund managers to think about environmental disruption. Yet, the fund selectors in our survey have mixed views about the ability of managers to identify and mitigate the impact of disruptive trends within their funds. While 66% are confident in fund managers’ competence when it comes to digital disruption, less than one-third say the same about environmental disruption. This indicates a challenge to fund managers to improve the narrative around how environmental factors are incorporated into investment decision making.
At the same time, less than one in five FTSE companies say they are disclosing detailed information on the strategic response they are taking to digital or environmental disruption within their corporate reporting.
In terms of environment, our study found that while companies believe this is key, only 9% believe they report on this in a meaningful way.ESG analysts can relate to this challenge. For example, low carbon is increasingly defined as aligned to a 2 degrees world, Paris-aligned, or otherwise “science based”. These targets are essentially commitments that are aligned to a trajectory to reach a 40-70% reduction in annual carbon emissions by 2030 from 2010 levels. The reality of this trajectory and potential scale of disruption is staggering and according to sciencebasedtargets.org (a partnership with the CDP, the UN Global Compact, WWF amongst others), at the present time, only 75 European companies have set actual science based targets. This is a relatively small group of companies, or around 20% of the MSCI Europe, which presents an issue for investors that are trying to assess the relative impact and materiality of various corporate climate initiatives.
Overall, among fund selectors, 58% want to see more information that links corporate social responsibility (CSR) activity to material business value. Historically, the CSR report has been separated from the business’s financial reporting. Investors increasingly need to see how this activity is driving and is linked to performance. For example, the most advanced companies, show how energy efficiency initiatives contribute to lower costs, they discuss specific capital allocation strategies or decisions and return objectives for lower carbon solutions.
Indeed, we regularly engage in dialogue with companies and clearly see increasing evidence of companies addressing environmental disruption. For example, the attractiveness of a paper and pulp company is enhanced by the investment opportunity the company sees in using wood instead of oils in their production processes, with overall lower carbon footprint. Their solution would have a competitive advantage by offering a transition towards cleaner plastics. At the same time, we regularly meet with oil and gas companies and see the rise in strategic commitments towards low carbon businesses as an important first step in being part of the solution for a lower carbon future.
Overall, our study found that companies are fairly pessimistic about the future and about half of the companies thought that 25-50% of the FTSE 350 would be displaced in the next 10 years. While this is a mixture of changing consumer preferences, regulatory, digital and environmental trends, this clearly highlights the importance for investors to consistently evaluate and integrate these types of drivers into our investment research. Focusing on a company’s management of disruption drivers and direction of change, as part of ESG analysis, is more important than ever before.
See the full report here.
Cathrine de Coninck-Lopez is Head of ESG for Invesco’s Henley Investment Centre.