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AXA IM’s Shade Duffy: Why pricing risk better matters

Having the right information for a risk/reward analysis is an investment prerequisite

Transparency is a key issue for responsible investment and good governance. Having the appropriate information to be able to conduct a thorough risk reward analysis is a necessary prerequisite for any investor to make well informed investment decisions. However, transparency depends on the level of disclosure offered by companies one is either invested in or looking to invest in. It is the role of good stewards to ensure there is enough transparency on key investment issues for investors to be able to price risk better.
For example, following COP21 at the end of 2015, there have been a number of discussions around the topic of mining resolutions. Many large pension funds and asset managers have signed up to the ‘Aiming for A’ initiative, which encourages mining companies to increase transparency and reporting on what climate change related risks mean for their business. While this could be perceived as somewhat of a simple ‘name and shame’ exercise in the first instance, or ‘pointing the finger’ at the sectors that are the most carbon intensive and therefore coming under increasing scrutiny as the issue of climate change intensifies, the involvement of investors in this matter is in fact much more complex.
There is no doubting climate change. In fact it seems that many companies have reached a level of understanding regarding climate change that demonstrates sophistication and maturity, which could suggest readiness for effective engagement on the topic. The pension funds and asset managers that have signed up to the mining resolutions initiative, for example, are trying to use this momentum in order to encourage increased transparency from the sector regarding the impact of climate change. The key motivation is to improve the flow of information from these companies to investors, which would ultimately help investors better price the risks involved in their investment decisions regarding the mining industry.
Transparency in this case is not only good for the investors in these companies, but should also benefit the companies themselves.Transparency should encourage companies to accelerate necessary changes to their business models that will take full account of the effects of climate change, which are likely to only become increasingly apparent in the coming years.
‘Why not simply divest?’ one may ask. Once again the issue is not that simple. While divesting from sectors completely could perhaps be the easiest solution at face value, it’s not necessarily the responsible approach to take. To continue with the example of mining, the industry continues to provide goods where there is currently no suitable replacement. Therefore, a complete divestment approach would in this case carry a number of negative side effects. It is the primary responsibility of active and responsible stewards to bring transparency and improve the flow of information to investors so that they can make more fully informed investment choices.
Pricing risk better matters because it allows investors to understand and prepare for the risks they choose to take through their investments. It gives room for planning and provides a better platform for assessing what other exposures are needed in a portfolio. It can also make investors more agile thanks to a better understanding of how their investments are impacted by different market environments and events. It plays a significant part in achieving the desired investment outcomes. Without disclosure and a full understanding of all of the risks involved, investors cannot make fully informed investment decisions, which can ultimately lead to unexpected losses or otherwise disappointing investment outcomes that don’t match the desired results. Climate change is a phenomenon that will have a significant impact on a range of industries and businesses, therefore it is crucial that investors understand the full range of risks and issues involved related to climate change when making investment decisions.

Shade Duffy is Head of Corporate Governance at AXA Investment Managers.