Commentary

If you are Standing Still, you are Falling Behind

Innovation can create opportunities for climate progress and investment returns in 2023, says Sarah Bratton Hughes, Head of Sustainable Investing, American Century Investments.

We believe the long-term drivers for sustainable investing remain strong, despite a rapidly changing economic and policy environment and ESG ‘pushback’. Even as the physical impacts of climate change drive costs higher, we see innovations in products and services creating significant opportunities for progress and investment returns.

In the short term, we believe the current energy and food crisis will drive up global emissions. But the need for energy independence and rapid innovation should accelerate the transition to renewable energy and may generate attractive investment opportunities.

Don’t mess with Texas

While the comptroller of Texas has become persona non grata in the sustainable investing arena, we will boldly assert that the United States and the entire world (including sustainable investing leaders) must recognise that the path to decarbonising must involve Texas. Despite being the most vocal state in the ‘anti-ESG’ debate, Texas is leading the way to decarbonising in the US.

Texas leads in terms of renewable power. It has a massive and growing fleet of renewable vehicles, and zero-carbon electricity sources (wind, solar and nuclear) powered about 38% of the state’s power in 2021, rivalling natural gas at 42%.[1]

Texas is the largest producer of wind power in the US (more than the next three states combined) and has surpassed California to become the largest producer of solar energy. Texas (and neighbouring states like Louisiana) also has the skilled-worker base needed to increase offshore wind power, given its experience with offshore oil rigs.

We believe Texas is misunderstood. It is neither ‘anti-ESG’ nor anti-environment. The ‘E’ it finds offensive is exclusion. We get it. We are steadfastly committed to the principles of a ‘just transition’ and believe support for these principles will increase in 2023.

We believe this transition must be a ‘down escalator’ not a ‘down elevator’. We must commit to reskilling workers and supporting communities and countries most impacted (and often the least responsible) as the world decarbonises. That is our investment stewardship approach, particularly concerning portfolio decarbonisation.

From best-in-class to best-in-progress

Historically, sustainable investing has focused on ESG integration, best in class, exclusions or a combination of the three. A recent survey by the research firm Kirstein in partnership with American Century Investments shows that leading asset owners in the Nordics and the Netherlands are shifting away from best-in-class investing toward best-in-progress investing.

We believe this shift is occurring for two reasons: Exclusionary approaches haven’t achieved much in terms of real-world outcomes, and best-in-class strategies often emphasise growth stocks, which was good until it wasn’t.

A recent study, ‘Decarbonising Institutional Investor Portfolios’, highlights hiccups in widely used portfolio decarbonisation approaches, historically a combination of exclusions and portfolio tilts (best in class). The authors’ conclusion: “Overall, our paper raises the concern that addressing the steep challenge posed by climate change and energy transition requires more than portfolio tilts. Institutional investors that decarbonize their portfolios via tilting may just be pushing away the problem to other investor groups that might be even less motivated to tackle corporate carbon emissions.”[2]

We believe best-in-progress approaches will increase as sustainable investors realise that diversification and engagement are crucial to meeting long-term return, risk and sustainability goals.

From quicksand to concrete?

During the first half of 2022, I often said we were standing on sand about the regulatory environment. But given the rapidly changing global conditions in the year’s second half, I switched to saying quicksand. And noting that sand is a primary ingredient in concrete, we’re optimistic that markets will gain regulatory clarity in 2023.

Nonetheless, asset managers will face a balancing act as various regulatory jurisdictions may be at odds with each other regarding goals and implementation. We remain concerned that rather than just tackling greenwashing, this may have the unintended consequence of stifling innovation.

Sustainability trends beyond carbon

Decarbonising will remain a hot topic in 2023, but we think other themes will also gain traction.

  • Food and Biodiversity – Both food and biodiversity were areas of focus for us in 2022, and we believe the intersection of the two will gain momentum in 2023. It became clear to investors in 2022 that as over half (55%) of the world’s gross domestic product (US$41.7 trillion) depends on healthy biodiversity and thriving ecosystems, biodiversity risks and opportunities should be considered when assessing environmental impact and innovation opportunities in a portfolio.[3] Combine that with a global food crisis and the knowledge that agriculture and food production harm the environment by depleting natural resources and contributing to greenhouse gas emissions. Investors will have to balance the short-term need to feed people against the long-term goals of decarbonising and restoring healthy, sustainable ecosystems.
  • Workers Back in the Spotlight – We see an interesting dichotomy as inflation soars and many countries are either close to or in a recession. Workers are starting to feel the impact of large scale layoffs and hiring freezes in specific industries, especially technology. At the same time, other industries still can’t find enough workers, particularly for lower-paying roles. We believe companies that treat their employees as assets rather than liabilities will be more durable over time. Companies that not only offer competitive pay and benefits, flexibility and training but also demonstrate compassion during turbulent times will likely be rewarded with less turnover, a stronger corporate culture and greater employee engagement. Consumers may also reward them. All this has been shown to support shareholder value over time.
  • Cyber – In our view, the relentless growth in digitalization, globalisation and the ability to work remotely (accelerated by the COVID-19 pandemic) mean that every company is now a technology company. The world becomes more connected daily and the increasing frequency of cyberattacks makes it more critical than ever for companies, communities and governments to have strong cyberdefenses to protect against exposures that could result in fines, reputational damage or cyberwarfare.

Sustainability depends on innovation

“If you are standing still, you are falling behind.” This statement is truer in sustainable investing today than ever before. Geopolitical tensions, rising inflation, a global food and energy crisis and other emerging trends make it increasingly critical for investors to avoid managing these issues using a siloed E-S-G or exclusionary approach. Instead, we must view them holistically to ensure a more just and sustainable economy for the future.

[1] Ella Nilsen, ‘Wind and solar power are ‘bailing out’ Texas amid record heat and energy demand,’ CNN, June 14, 2022

[2] Vaska Atta-Darkua, Simon Glossner, Philipp Krueger and Pedro Matos, ‘Decarbonising Institutional Investor Portfolios,’ September 7, 2022

[3] World Economic Forum, ‘Half of World’s GDP Moderately or Highly Dependent on Nature, Says New Report,’ News Release, January 19, 2020

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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