Clients must scrutinise investment managers

Will Oulton, global head of responsible investment at First State Investments, analyses investors’ strategies and examines their green credentials

Fossil-fuel companies are no strangers to controversial headlines over damaging oil spillages, health and safety or human rights issues, and, more recently, the debate on the case for continuing investment in the sector.

Through active campaigning and lobbying, environmental and climate groups have generated media coverage which, in some quarters, has created a perception that fossil-fuel firms have become somewhat of a bête noir of investment portfolios.

Such commentary is based on concerns about the long-term viability of their business models. The reality, however, is that very few institutional investors have divested their fossil-fuel holdings, and those that have are mainly the campus-orientated foundation and endowment funds.

The main arguments for divestment are value led and based upon the very laudable notion of climate protection, with the added strength of the message which it delivers to policy-makers and financial markets around the world.

On the other side of the climate-protection coin is the argument that fuel companies are overstating the value of reserves on their balance sheets because they will become stranded as the world reaches its proposed limits of carbon emissions.

Increasing numbers of investors are of the view that a company’s sustainability positioning is a key driver of its long-term performance

Many institutional investors are following the stranded assets work with great interest, as it fits with a prudent risk-management approach to investment and the stewardship of their clients’ assets. However, more work is needed and being done to develop this thinking and analysis further.

An approach that is gaining increasing interest is the notion of sustainability in investment strategies. In investment terms, this seeks to select those companies which will contribute to and benefit from the sustainable development challenges of the countries where they operate. The problems include environmental degradation, resource scarcity, population growth, social inequality and unrest, as well as extreme poverty.

Increasing numbers of investors are of the view that a company’s sustainability positioning is a key driver of its long-term performance. They are therefore looking to invest in portfolios of such companies where it is clear they can benefit from moves towards tackling environmental and societal problems, such as infrastructure, resource efficiency, healthcare and sustainable client-centric finance, as well as environmental and low-carbon technologies and services.

These portfolios naturally tend to avoid companies in highly carbon-intensive sectors, not to mention tobacco and gambling, and are often selected by climate and environmentally conscious investors.

A persistent myth about sustainable and ethical investment is that there is, by definition, a performance sacrifice which comes with these approaches. This is nonsense as many such strategies perform handsomely compared with their non-sustainable peers.

However, this is only part of the story. Investors need to understand the selection criteria for such funds and the skills, competencies and experience of the investment managers running them, plus, importantly, how they are acting as stewards of their money.

Investors have many options when placing their capital, but their approach will be driven by particular beliefs or values and implemented by investment managers. It is the managers and their approach to stewardship that needs more scrutiny, which has so far been lacking on the part of clients.