Investors should avoid oil companies advocating a business-as-usual growth strategy. US oil giant Exxon has pursued a business-as-usual growth strategy that has underperformed the wider market and peers, said Mike Coffin, head of oil, gas, and mining at Carbon Tracker Initiative who said shareholders of the oil group have only been rewarded because of the cyclical nature of the oil industry.

He said that unlike food production or transport, oil and gas cannot be decarbonised. Oil and gas groups should set goals with an absolute basis for reduction that incorporates end use emissions and downstream products, not just their Scope 1 and 2. He said these targets need to be framed to protect investors; companies plans must be appropriate, exclude divestment and not too dependent on unproven technology.

A low carbon, Paris-aligned world will result in a rapid decline in global demand for oil and gas. This means there is no need for new projects, and existing assets will be able to meet demand. “There is already enough oil and gas out there from production from existing projects to supply demand in 1.5-degree scenario,” he said.

Limiting warming to 1.65 degrees would only allow a small number of new projects to go ahead, yet Coffin said some oil and gas groups are planning a whole range of projects that would go over this scenario. These projects will be stranded; they will destroy investor value and will take the world over emissions targets.

He said that these projects will also take companies up the cost curve in pursuit of growth that amounts to a bet against Paris. “Companies sanctioning these projects are not Paris-aligned.” He suggested oil and gas groups should let their existing assets decline naturally in a runoff strategy that is better for investors and the environment. Alternatively companies can reframe their business away from oil and gas, and either return money to shareholders or invest in new, long term green projects.

No excuse

Coffin said the energy crisis, most prevalent in Europe, following Russia’s invasion of Ukraine shouldn’t put growth back on the table for oil and gas groups. Projects take five years to come to fruition, and demand will rapidly weaken over the next decade, he said, warning of  prices crashing and projects being left stranded. “If you sanction projects now, even if there is demand now, when projects are up and running demand will be in a decline phase.”

Coffin said that if petro-states claim alignment to the Paris goals, they can not justify supporting new projects, and are investing based on short-term prices with risky lead times.

Fellow panellist Mark Campanale, founder, Carbon Tracker Initiative called what lies ahead the biggest reallocation of capital in history. He said the technology behind internal combustion has not changed much in 200 years – it remains inefficient, cyclical and geopolitically dependent. In contrast, renewables are more efficient, not cyclical and once installed are not as volatile as fossil fuels.

He said that all the cheap access to fossil fuels has been found, noting that transporting fossil fuels will become more expensive. In contrast, renewable energy gets cheaper the more it is built. “This is the key distinguishing factor,” he said.

As the price of renewable energy falls, so competition steps up. He said that he had encountered policy makers who didn’t realise that renewable energy is cheaper than fossil fuels. “Renewables are experiencing falling rates and will continue to,” he said. He also noted that ESG-aligned private equity investment does not equate to capital flowing into renewable energy. He said investors need to allocate directly to the sector, especially in the global south.

He noted that the rise in electric vehicles will increasingly dampen oil demand in a trend most visible in China where electric busses are increasingly prevalent. He said air pumps will displace gas boilers where technology and take-up will also lead to a sharp drop in their price. This will be another factor leading to markets discounting fossil fuels.

Earnings calls

Elsewhere he noted how references to carbon in earnings calls has risen sharply. “Climate and carbon have become one of the crucial topics for boards and earnings calls,” he said.

Campanale said that Exxon’s decision to continue to build more capacity and volume echoed companies like Blockbuster video and Kodak that both missed the digital revolution.

He noted that the business model of oil and gas groups is based on producing a product cheaply to sell at a higher price, yet renewable energy is not built on the same model. Oil and gas is high risk; renewables are based on long-term returns. Oil and gas groups could wind down and return money to shareholders, invest in renewables or become providers of new technology around carbon capture for industries that can’t decarbonise.

The panellists also reflected on the importance of aligning executive pay with the transition, something that still doesn’t happen. Executives in the oil and gas sector are still incentivised to grow production.

In this live recording from Sustainability in Practice, hosted by Top1000funds.com at Cambridge University in April 2022, Professor Julian Allwood speaks with Colin Tate.

About Professor Sir Julian Allwood

Julian Allwood is Professor of Engineering and the Environment at the University of Cambridge. From 2009-13 he held an EPSRC Leadership Fellowship, to explore Material Efficiency as a climate mitigation strategy – delivering material services with less new material. This led to publication in 2012 of the book “Sustainable Materials: with both eyes open” – listed by Bill Gates as “one of the best six books I read in 2015.”

Julian was a Lead Author of the 5th Assessment Report of the Intergovernmental Panel on Climate Change (IPCC) focussed on mitigating industrial emissions. Amongst others, he was elected as a Fellow of the Royal Academy of Engineering in 2017.

From 2019-24 he is director of UK FIRES – a £5m industry and multi-university programme aiming to explore all aspects of Industrial Strategy compatible with delivering zero emissions by 2050. ‘Absolute Zero’, the first publication of UK FIRES attracted widespread attention including a full debate in the House of Lords in Feb 2020, and has led to a string of other reports, research and impact.

In this live recording from Sustainability in Practice, hosted by Top1000funds.com at Cambridge University in April 2022, Professor Sir David King speaks with Amanda White.

About Professor Sir David King

Professor Sir David King is Emeritus Professor of Chemistry, University of Cambridge; Founder and Chair of the Centre for ClimateRepairin the University; Chair of the Climate Crisis advisory Group; an Affiliate Partner of SYSTEMIQ  Limited;  Senior Strategy Adviser to the President of Rwanda and founder member of the Clean Growth Leadership Network, CGLN. He served as Founding Director of the Smith School of Enterprise and the Environment at Oxford University, 2008-2012, Head of the Department of Chemistry at Cambridge University, 1993-2000, and Master of Downing College Cambridge 1995 – 2000.

He was the UK Government Chief Scientific Adviser, 2000-2007, the Foreign Secretary’s Special Representative on Climate Change, 2013-2017, and Chair of Future Cities Catapult, 2012-2016. He has travelled widely to persuade all countries to act on climate change. He initiated an in-depth risk analysis approach to climate change, working with the Governments of China and India in particular, and initiated a collaborative programme, now known as Mission Innovation, to create a £23bn pa research and development international exercise, which involves 22 countries and the EC, to deliver all technologies needed to complete the transition into a fossil-fuel-free world economy.

In June 2021, he launched the Climate Crisis Advisory Group,CCAG, a global team of 15 climate experts drawn from 10 countries who give monthly public (virtual) meetings on their work, available to all. CCAG are able to respond, with authority and quickly, to current needs in the process of protecting our future, with advice on the actions needed to deliver this effectively and safely.

He was born in Durban, educated at St John’s College Johannesburg and at Witwatersrand University, graduating in Chemistry and a PhD in physical chemistry. He has received 23 Honorary Degrees from universities around the world.

As Govt Chief Scientific Adviser he raised the need for governments to act on climate change and was instrumental in creating the British £1 billion Energy Technologies Institute. He created an in-depth futures process which advised government on a wide range of long-term issues, from flooding to obesity. He was Member, the President’s Advisory Council, Rwanda, and Science Advisor to UBS, 2008-12

He has published over 500 papers on surface science and catalysis and on science and policy, for which he has received many awards, medals etc. and 23 honorary degrees from universities around the world.

Elected Fellow of the Royal Society in 1991; Foreign Fellow of the American Academy of Arts and Sciences in 2002; knighted in 2003; made “Officier dans l’ordre national de la Légion d’honneur” in 2009.  In Feb 2022 he was awarded the David and Betty Hamburg AAAS award for Science Diplomacy

Managing liquidity stresses is a fact of life for defined contribution funds, but the unprecedented early release schemes introduced by both the Australian and United States governments during the onset of Covid-19 brought this challenge to a new level.

The superannuation landscape may be permanently changed on the back of this precedent, and collective defined contribution plans such as Australian superannuation funds and UK master trusts need to be prepared for either participant actions such as member switching, or government actions such as early release schemes, argues Michelle Teng of PGIM in a new research report (Super Funds & Master Trusts in a World of Member Switching, Early Release Schemes & Climate Calamities, available via the link).

Speaking to Conexus Financial managing editor Julia Newbould on the ‘Insight for Outcomes’ podcast series, Teng said funds were facing the confluence of two liquidity-challenging trends: the introduction of early release schemes and encouragement from governments that they support economic growth by investing in illiquid private assets like private equity and infrastructure.

Prudent CIOs are unlikely to keep asset allocations unchanged in the face of this new landscape, Teng said.

“Generally, CIOs would move some of the risk-seeking assets, which tend to be less liquid, to lower-risk and more liquid assets, for example from private assets to stocks, or from stocks to bonds and cash,” Teng said. “This change of portfolio allocation to better manage liquidity risk incurs a hidden cost of expected portfolio performance that affect all participants.”

But holding extra liquidity comes at a cost to performance, and funds cannot afford to respond to heightened liquidity risks by simply becoming defensive, particularly now that Australian funds are subject to the Australian Prudential Regulation Authority’s annual performance test, Teng said.

Rather, they need more advanced tools to help them quantify the cost of adapting their portfolios and make more confident asset allocation decisions.

“The challenge for CIOs is to coordinate their top-down asset allocations with their bottom-up private asset investing activities, and in the meantime they need to meet a number of liquidity demands,” Teng said.

Newbould asked whether early release schemes had shown governments may be willing to make funds available during natural catastrophes, which may become more frequent as the planet warms up.

“The short answer is we don’t know, but there is a possibility,” Teng said.

Members may rightfully question the point of having a retirement plan if they cannot afford to rebuild their house, she said, noting the United States passed legislation in 2021 allowing disaster distributions from retirement plans for calamities other than the Covid-19 pandemic.

More broadly, the impact of these decisions from governments will go far beyond the Covid-19 pandemic, Teng said, raising awareness across the industry about how to better manage liquidity.

Industry participants, including policymakers, need to better understand the tradeoff between the liberality of early access programs and expected portfolio performance in the long term, she said.

“Our research may help governments and policymakers identify portfolio allocation consequences and costs of contemplated rule changes,” Teng said. “These costs would be borne by all participants.”

Globalisation hasn’t died, it’s just going native.
Until recently, globalisation was perhaps the second-most fervently held article of faith for asset managers and allocators. The conviction was twofold: first, that globalisation was a good thing, and second, that it was on a one-way track.

In the words of economist John Maynard Keynes, referring to how contemporaries viewed the pre-1914 golden age of globalisation, “…most important of all, he regarded this state of affairs as normal, certain, and permanent, except in the direction of further improvement, and any deviation from it as aberrant, scandalous, and avoidable.”

Globalisation in asset management was born on portfolio managers’ trading screens, with ever-more integrated capital markets and vanishing capital controls. Its next manifestation was in fund passporting schemes (UCITS being by far the biggest).

Soon enough, allocators the world over started relying on similar yardsticks to identify and select managers (midwifed by investment consultants who themselves went global in the 2000s). Finally, globalisation made its way to regulators, with talk of “harmonising” approaches to regulating markets and the fund industry.

For allocators, what mattered was the substantial expansion of their investment universe and the frictionless deployment of capital across borders. For asset managers, globalisation meant scale: a single platform housing investments, operations, and business management, ideally in one location, powering a common set of strategies and products for sale globally. The 2008 financial crisis slowed things down a bit, particularly regulatory harmonisation, but the direction of travel didn’t change.

This model was upended, first gradually, and then suddenly. The gradual shift was the rise of the individual investor, who eclipsed institutions in terms of total dollars deployed, expected future flows, and fees paid. The primacy of individuals is leading to a more regulated industry centered on local vehicles, focused on local asset classes, and characterised by investors with diverging needs and levels of financial literacy.

The sudden shift was the steady staccato of ruptures in the global financial fabric: trade wars, pandemic, hot war, sanctions. Here the impact has been in the investment function: impeding the free flow of capital, policies that channel savings locally, permanently altered supply chains, and introducing politics as a major non-economic driver of asset valuations. All of these factors tilt the balance in favor of deeply local investment strategies and managers.

But globalisation isn’t gone. For one thing, the diversification benefits are too compelling. Furthermore, the majority of markets remain lopsided in one way or another: for example, not enough local debt issuance, or equities that lack any meaningful exposure to younger, dynamic, future-oriented companies. The potential exceptions are China and the US (bearing in mind that in China capital controls are firmly in place, and ESG adds further hurdles).

The post-2022 globalisation is a series of deeply rooted local investments that together result in a global portfolio. This model lacks the simplicity, ease-of-use, and scale of the 1991-2021 globalisation. It requires a thoughtful approach, guided by political inputs rather than solely financial inputs. For managers, the pursuit of global synergies will lead to disappointment: other than in a few corners of the industry (large institutions, select alternative strategies) there will be very little global operating leverage across the four major asset management markets of the US, EU, China, U.K. (that together account for over 80 per cent of investable assets). When it comes to demographics, product preferences, regulatory model, the role of ESG, and the role of policy in the markets—US, EU, China, and UK are sui generis.

Staying global will be an exercise in prioritising a few markets to go deep, rather than trying to access every market. The effort required to be successful in any one place will inhibit all but the very largest players, and local leaders will usually have an embedded advantage—sometimes explicitly, via regulatory favor.

This new, fractured globalisation is creating new winners and new investment opportunities.

The rise of politics and ESG as major non-economic valuation drivers requires a fresh look at investment processes and philosophies built on a now-irrelevant pricing data set. Diverging individual investor needs creates demand for new products and investment approaches. What remains unchanged is the single most fervently held article of faith for both managers and allocators: markets, in the long run, go up.

Daniel Celeghin is managing partner at INDEFI

Investing for sustainability impact is relevant for all investors and they should consider doing so where it can help meet their financial objectives, said David Rouch, partner at law firm Freshfields, Bruckhaus Deringer and lead author of ‘A Legal Framework for Impact’, the so-called Freshfields Report.

Published last year, it explores to what extent can and should institutional investors use their power and influence to generate a positive sustainability impact, exploring the role of the law in supporting this process.

Speaking at Sustainability in Practice at Cambridge University, Rouch told delegates to continue seeking to influence companies for impact as an effective way to achieve their financial goals.

“Continue doing what you are doing,” he said.

The report, launched by PRI, UNEP FI and The Generation Foundation, lays the foundation for the financial policy reforms needed to reorient investors, markets and economies towards net zero and inclusive, sustainable economic growth.

It follows on from the first Freshfields report of 2005 which concluded that investors are permitted, and arguably required, to integrate ESG factors into their analysis, and the subsequent UNEP FI, PRI and Generation Foundation program: Fiduciary Duty in the 21st Century, which determined that ESG factors must be considered for investors to meet their fiduciary duties. All these legal developments amount to building blocs to the infrastructure supporting sustainability and impact investment.

legal pinch points

The latest report found that across 11 jurisdictions, investors are able to pursue sustainable impacts (via, for example, stewardship, policy engagement or divestment strategies) if they are an effective way of achieving financial goals. Rouch said investors can pursue impact to achieve their financial goals that are put at risk if those impact are ignored. In this way, investors are instrumentally seeking sustainability goals to achieve broader financial goals.

The study has revealed various legal pinch points however. For example, how will pension funds assess if they are having any influence on the third party?

It flagged potential issues around a pension fund’s ability to divest and the importance of investors and asset managers remaining unbiased, continuing to represent all their investor or beneficiary cohort who might care about different impacts.

“Investors have to be impartial,” he said.

Pension funds will also have to factor in cost, balancing the cost of engaging with the impact on the fund. It makes collective action an important decision, he said.

Evidence is a crucial element of the legal process. If investors are ever challenged in court, they may have to provide evidence that the benefit outweighed the cost. He said in such a circumstance, the court will always look at the process behind the decision making; charting how investors take responsible decisions based on evidence and properly consider the risk of sustainability and what the fund can realistically do about it.

“A court will be influenced by good industry practice – but it is virgin territory.”

Collective action

Rouch also noted how successful sustainability and impact investment requires collective action, however this can come with legal challenges.

For instance, one of the challenges with collective action is that the results are enjoyed collectively – and success depends on collective action. It could leave investors struggling to define what contribution they have made to the collective outcome – or what benefit they derived from the collective action.

He said that if by pursuing sustainable impact investors can protect the value of their fund, then logically they should be doing it.

He concluded that one of the biggest challenges is getting people to understand the legal arguments, noting that US investors are particularly anxious around these issues. He said the investment community needed to embed this into their practice outside the legal and consultancy world which is more familiar and comfortable with these concepts.