Finance & Markets
they are obliged to take care of money on behalf of their clients. The weakness of this approach is that it fails to explore longer- term risk or impacts, and can keep organisations locked into trajectories that are potentially harmful to both the environment and longer-term performance. By adopting a short-term investment horizon, there’s no motivation to take a long-term view. 3 Side-stepping The focus here is on people trying to boost their knowledge and understanding around climate change, and to develop metrics and tools that enable them to integrate climate-related factors into investment analysis. The advantage is that the issue of the environment and climate change remains in the spotlight, so in theory it should be factored into any thinking or analysis. In reality, however, there’s potential for this knowledge to remain divorced from any investment decision-making, and a risk that such an exercise only serves to delay decisions. This neither solves underlying tensions nor impacts on investment strategy. 4 Expert advice Many investment institutions now employ environmental, social and governance (ESG) analysts, who specialise in climate-related or broader ESG issues. By deferring to them, investors can make use of expert advice rather than having to acquire knowledge, or set strategy, themselves. For investors, this has the advantage of effectively passing the responsibility on to someone else. The downside is that, in many institutions, such ESG analysts tend to be less powerful than the portfolio managers who ultimately
institutional investment firms around the ambition to support climate-change mitigation and the need to generate financial returns. It outlines six approaches that sustainable finance professionals adopt to address such climate-related tensions. 1 Sequencing along steps Sequencing along steps means investors try to consider both priorities on their own merits. They might first conduct a climate impact analysis and then a financial analysis, so they don’t interfere with each other. This might suit a fund that is looking to generate returns but also wants to benefit the environment. The advantage of this is that both priorities are considered on their own terms. However, at some point, these two elements must be brought together. The win-win scenario is if they both show benefits, and investments can go ahead knowing that both elements have been fairly considered. But, when they conflict, financial objectives dominate. In cases where an analysis suggests lower returns or higher risks, this can prevent investments in climate mitigation or adaption. 2 Doubling down In this strategy, investors undertake a traditional investment analysis, focusing on financial materiality and objectives. The advantage is that it’s clear what the priorities are, and there’s no pretence around a motivation considered, it’s within this lens, assessing their potential impact on financial returns in the short term. This also means investors are undoubtedly in line with their fiduciary duty, under which being to benefit the planet. Where climate issues are
TO THE CORE
1. Finance professionals have developed six common approaches to balancing sustainability with the need to generate returns for their clients. 2. They can double down on financial objectives, develop new metrics to incorporate climate factors into investment analysis, or analyse climate impact and financial returns separately. They can also try to pass responsibility for decisions on to the client or expert advisers, or use engagement advisors to ‘nudge’ the companies they invest in to take action on climate change. 3. None of these fully resolves the
F or many years, manner that does not harm the planet while still expecting strong financial returns. For a while, such efforts were based around the widespread idea that climate change mitigation efforts were inherently also good for the bottom line, in a scenario laced with wishful thinking that seemed to suit all parties. Recently, though, the rise of climate-change sceptics has challenged this, forcing many organisations to question their own priorities. Our research sought to explore the tensions that exist within institutional investors and asset managers have trodden a fine line when it comes to sustainable finance, seeking to pressure organisations to operate in a tension between financial and environmental returns. Finance professionals need to discuss those limitations and the trade- offs required.
6 Engagement This approach involves calling on an engagement specialist to ‘nudge’ companies to take their own action on climate mitigation. The advantage of this for institutional investors and asset managers is that it separates the two objectives. The investment firm can focus on achieving financial objectives through their capital allocation, while the engagement team can encourage those businesses to pursue climate objectives. The downside is that the tension shifts to the external business. Investing in climate mitigation can be costly, and might not be supported by other investors. Ultimately, the decision will lie with the business rather than the investment institution. Some may engage, while others opt to stick with their current arrangements. For the investment firm, this is a risky strategy, relying on their influence rather than action. We saw all six strategies used during our research. Shifting the tension to engagement was the most prominent, but transferring it to
make investment decisions. In turn, this means ESG analysts often adapt their thinking to suit the audience they must convince. This can result in financial objectives coming to the fore, often at the expense of climate mitigation and adaption. 5 Shifting the tension Shifting the tension is another strategy that can be deployed. In theory, it’s the asset owner who should dictate how investments are made. But, when it comes to selecting specific companies and projects, this decision is often delegated to the asset manager. In this scenario, the asset manager could insist the asset owner makes the call around whether financial or climate objectives are more important. The potential upside for managers (or asset owners who do the same) is that they might succeed in passing responsibility to someone else. The downside is that the issue might never be resolved, and the tension just keeps flowing between the two parties.
ESG specialists was also common. However, none of these approaches were fully effective in resolving the tension between environmental and financial returns. Sustainable finance professionals and the organisations they work for must be open about the need for them to do more to tackle climate change, the likely trade-off that will be required, and the limitations of the current approaches. What’s needed is an honest conversation about the elephant in the room: that reducing the environmental impact of investments, means potentially accepting lower returns. Only then can institutional investors, clients and businesses adopt a firm position where it is clear exactly what their priorities are, and what the implications are for climate mitigation efforts.
Invest in your future with the MSc Finance at WBS.
Sustainable Development Goals
Warwick Business School | wbs.ac.uk
wbs.ac.uk | Warwick Business School
26
27
Made with FlippingBook Learn more on our blog