The CFA Institute’s Diversity Equity and Inclusion Code could result in a fundamental review of practices in some asset owners and managers according to Sarah Maynard, global head of external inclusion and diversity strategies and programs at the institute.

“There are just so many repeat mistakes we see that can be resolved,” Maynard. “They require considerable attention to detail and a change in practice. This is not about an overlay but a fundamental review. For some firms that won’t be major change and for others it will.”

The DEI code, which launched for consultation in the US and Canada last month and will close in September, is a principle-based code seeking to accelerate a change in behaviour.

“You don’t achieve change without disruption and discomfort and we are asking managers to embrace that,” she says.

The code is rooted in six principles: pipeline, talent acquisition, promotion and retention, leadership, influence, and measurement.

It is the culmination of a collaboration between CFA Institute and a working group of industry leaders, including the experimental partners program which included asset owners such as Texas Teachers, BCIMCo, and Australia’s VFMC. The partners have chosen up to three of the 20 action points from the CFA guide Driving change: Diversity and inclusion in investment management and have been implementing those in their organisations for the past two years. The full report of the experimental partners findings is due to come out later this year.

The DEI code is designed to foster a metrics-based commitment from signatories with the principles underpinned by the implementation guidance and reporting framework which requires annual reporting. The CFA Institute plans to publicly report on industry-level statistics.

While the code includes high level principles, Maynard says the differentiator is the level of detailed guidance that supports the principles. For example it outlines for firms at the beginning of the process what their first steps should be; and outlines how to be more inclusive even if a firm is not yet diverse.

“What is interesting to me is trying to take this out of its silo,” Maynard says. “A lot of this is good management, good practice and everybody benefits.”

She also points out that the code was written by a working group made up of investment professionals.

“We had a lot of great support from DEI experts within those firms and others, it’s been a huge collaborative effort. But owning it in the business is a critical piece. Part of the way the industry is moving is the real leaders see it as a business priority and the right thing to do as they increasingly talk about purpose and values.”

In case you missed it, the forthcoming COP26 climate conference recently joined the Olympics, the World Cup and other big events with various commentators marking its ‘100 days to go’. Such a catchy media tag line is popular with everyone it seems. For investors, you wouldn’t expect them to go scrambling into their diaries to blank a week off to focus on proceedings. Or even schedule to record on TV to make sure not a minute of the riveting policy discussions is missed, should inconvenient day job workloads force them to miss the live action.

However, if you sit on the board of a pension fund or an insurance company you might ask how we suddenly arrived a point where all stakeholders are talking the language of net-zero, and some are staking their reputation on it?

Only a short time ago, ex-President Trump and his cohorts were so proud of their achievements in trying to halt the low carbon transition that it seemed the language, and prospect, of ‘hot house earth’ and runaway climate of 4 or 5 degrees was perfectly reasonable.

Whilst the new IPCC report is certainly alarming at the apparent sensitivity of the climate to emissions, and cements urgency as the way forward, from a pure emissions quantity perspective, the worst cases can now be ruled out.

As the Inevitable Policy Response (IPR) programme showed us in 2019, even the assumption of a second Trump term would not be enough to stop the momentum behind a policy acceleration in the 2020s, driven by a combination of EU policy leadership, the rapid change in the economics of renewable energy and institutional pressure from large investment funds. This latter pressure culminated in May in the unforeseen signal of investor preparedness to sack oil company board members to force a transition strategy, rather than divest their shares.

In 2019 some investors thought IPR was way too ambitious in its transition forecast but much of it eventuated. After the Trump veil was cast aside the realities of the underlying transition momentum were much clearer. Indeed, once the Biden bridal party was installed it was Black Friday sale for everything net zero as countries, funds and companies queued up to announce their own commitments. Now we have climate policy shifting into the end game of the WTO, G7 and G20, there is little turning back.

Following this burst of pent-up momentum, it would be natural for some asset owner boards that treat climate primarily as a watchlist issue, to tick the box and think job done?

Au contraire, sadly, as we are still in the initial stages of transition impacts on portfolios. How can we expect asset owner boards to really understand the complexity of the transition given the nature of interacting drivers of the acceleration between geopolitics, institutional pressure and technology?

This is a complex enough issue for the giants of public markets so what can an asset owner board really do? Certainly, a house view on the future is critical, as opting for a standard asset allocation with a reliance on passive indices and the wider market to sort the mess out is unlikely to yield optimal results.

In a world increasingly dominated by temperature constrained scenarios, the greater realism of the IPR forecast has been welcomed by leading asset owners and managers alike. But the matching of reality to shorter term targets for with net zero commitments is creating sleepless nights for some, particularly insurance companies.

The spotlight now for boards is clearly towards the CIO and investment committee and the core processes of strategic asset allocation and manager selection. Overlaying forward looking return assumptions with the outputs of historically facing SAA models requires judgement and a pivotal decision to be active over this theme.

Stick with the status quo approach in both public and private markets and you risk following the herd so late that leaders have swallowed all the early investable and valuation opportunities.

And how do you discuss this with your asset managers? How do you encourage asset managers not to game the market timing by staying in assets which are clearly exposed in the long term?

If your active managers have built understanding on the theme and create some resilience by moving early to tilt your portfolio but the policies do not arrive to ensure profitable returns or market peers are slow to help boost associated low carbon valuations, then how do you discuss underperformance?

Ditto the decision on picking transition themed benchmarks and the unhealthy addiction to tracking error in some funds.

How does the board stay patient enough to back those managers in public and private markets reflecting their belief in the most likely future outlined in IPR while the managers promise that the rest of the market has not quite understood the issue?

Likewise for new thematic managers clearly with the right ideas but lacking the 3-year track record.

Add to this the huge complexity of picking which company transitions look credible and the discussions with managers become exceedingly difficult indeed. Trust in a long-term strategy is easier said than done when short term realities tempt asset owners back to the index to recover.

And what of the unlisted opportunities where much of the upside likely sits? Forestry in real assets seems as certain a long-term bet as any, with IPR forecasting an emissions overshoot that will require huge reforestation. Consider also other negative emissions opportunities and others in private equity, infrastructure and real assets.

With some asset owners revisiting asset allocation only every few years, a mad dash to re-allocate from equities holding the traditional incumbents, to backing the new era upside, is a behavioural cultural and process shift that may simply be beyond many boards.

For those that started this change early, a well navigated transition will yield superior returns, but for those setting their calendar reminders for COP26 for the first time, some degree of hope and luck will be required, a fact that is already instilling fear in many boards, making this the greatest investment governance challenge of their lives.

Julian Poulter is head of investor relations at the Inevitable Policy Response (IPR) and co-founder of Energy Transition Advisers and previously was CEO of the Asset Owners Disclosure Project (AODP).

 

 

Private assets have been steadily growing in popularity in recent years, with estimates that global alternative assets under management will have grown from 10 trillion dollars at the end of 2020, to 17 trillion dollars by 2025. So, what is it that makes private assets so attractive to clients? Why are they so useful as part of an investment portfolio? How can the issues of liquidity and complexity be solved, and what might their future hold?

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Greenwashing is pervasive and it’s no mystery why, according to Professor Stephen Kotkin, who says governments continue to sign on to mandates they cannot meet, and investors pledge commitments they cannot redeem, creating a lucrative industry in greenwashing.

At the same time, private automobile companies are far advanced in shifting to exclusive production of electric cars in the near term, consumers are already snapping up a variety of meatless “meat” offerings, and fossil fuel companies are having trouble investing in fossil fuels.

Even as the government-led mandate-and-pledge approach promotes as much of a political backlash as effective action, in other words, the private sector is already altering the economy fundamentally.  Kotkin contends that if governments in the largest economies focused on just two areas – carbon pricing and reinventing the grid – the greenwashing sector might crater as fast as it arose. 

“Governments, ESG-advocates, and institutional investors are not intentionally promoting greenwashing.  But when companies feel compelled to make pledges they cannot keep, even if they wanted to, they hire the consultants to demonstrate ‘compliance’ and get that necessary seal of approval for investors.  The intention is get to a better place, but the consequences are unintended and perverse.”

Kotkin, Professor in History and International Affairs and director of the Princeton Institute for International and Regional Studies, funds climate research, including international dimensions of the much-applauded Net Zero America team.

He cautions against a politics of sustainability that is itself unsustainable.  The climate change claims need to be humbler and strictly evidence-based: the scientific models in this complex area have been poor at prediction, the sine qua non of models.  Exhortation needs to give way: the infrastructure now in place, produced by more than a century of a fossil-fuel powered global economy, will not be transformed by ever-greater alarmism and spiralling pledges.  Do we really want more and more solar panels produced by brand-new coal-fired power plants?

“The big multinationals in the oil and gas industry are terrible at alternative energy but they have nowhere else to go except to commit to clean energy. They can’t not make the pledge,” he says. In place of pledges, and to eradicate greenwashing, the private sector needs to be allowed to lead, which it is already doing.

“Auto manufacturers are phasing out non-electric cars but there are no mandates to do that, they are doing it because of market signals. They are convinced consumers want electric cars,” he says.

Similarly, consumer demand for plant-based meat is forcing changes in food production, grocery shops, and restaurants.  “Like farm to table, plant-based meat is now a booming industry because producers are responding to demand.  More companies in the food business will pivot from cows and methane.  They have to because the market is pivoting.”

Kotkin, also a senior fellow at the Hoover Institution at Stanford, says investors will have a better strategy for sustainability if they mesh the two ideas: that greenwashing is coming from the zero mandates, and the real change is coming from consumers and responsive producers.  “We need a more limited view of what we are demanding from government and a more markets’ incentive view of change,” he emphasizes.

Right now, he notes, not enough product is being created for asset owners to achieve their aims, instead what is being provided is consultancy to navigate political waters.  The contortions for hard-pressed institutions to appear to be doing their part is now a thriving business.

“We don’t have the carbon pricing and the smart grid so we don’t have the product,” he says. “If we skipped the high-profile international gatherings, which signal commitments the participants could not possibly impose in the messy real world, and just got a carbon price that was used by the US, EU, China, and a few other key countries there would be a gold rush.”

New investment needed

Kotkin says that the climate challenge requires new investment on a staggering scale and the market needs to back “killer companies,” from alternative energy to sustainable agriculture.

“We need companies that are as good at alternative energy as ExxonMobil is at fossil fuels,” he says.  Subsidies rarely create killer companies.

One reason for lack of innovation, according to Kotkin who is a specialist in Communist regimes, is that China undercut the global alternative energy industry with massive state subsidies, enabling Chinese firms to grab market share by selling below cost.

“The solar industry in the US was undermined by China, but the China solar industry is inefficient.  Because of subsidies it was able to destroy other companies that were more incentivized to innovate,” he says.

Energy transition will remain a long-term prospect, no matter how urgent, though it can accelerate based on incentives, and savvy investors.

“You have to attack the problem where you can trigger a systems cascade. If charging stations are built then it would vastly accelerate the transition to electric cars.  At the moment electric cars remain a luxury even though demand-wise there is a latent mass market,” he says.

Kotkin also observes that measurement and metrics are a shambles.  “Right now there is no money in certifying actual compliance.  All the money is in pretend compliance, the incentives are upside down. We need metrics and measurement that are realistic, that companies can meet and a system to hold them in compliance. We need the right incentives for the big accounting firms, too.”

 

Professor Stephen Kotkin will speak at the Sustainability in Practice digital conference on September 8-9. The event is complimentary to asset owners.

One of the authors of Net Zero America, senior research scientist, Chris Greig from Princeton’s Adlinger Center is also on the program which will focus on how to achieve net zero.

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Antiquated risk management practices will be forced to evolve to accommodate climate risks. By estimating the future instead of just measuring the past, risk managers will own the beliefs and strategies that underpin their projections researchers at FCLTGlobal predict.

Climate change is an unstopped force – not unstoppable, but so far unstopped – and it is crushing seemingly immovable ideas about investing. At the center of this collision is our seventy-year-old way of thinking about risk. That’s right, we still manage investment risk using core methods that were born in the 1950s.

In investment terms, an unstoppable force is a “trend,” or a movement of asset prices that continues without reverting to the mean, and that consequently wrecks the distribution of price changes. The variance statistic depends on a stable distribution, and variance in turn underpins all of the risk statistics that are familiar to investors, from standard deviation to Sharpe and Information Ratios.

As the unstopped force of climate trends meets the immovable object of variance-derived risk management, it will be the risk techniques that move first.

In no way does this mean that investment risk management is leaving the domain of statistical summary for look-back reporting and probabilistic estimation for projecting the future. It means instead that risk managers will have to shoulder the responsibilities of discretion that portfolio managers already carry. Specifically, they will have to choose time horizons deserving of focus, specifications about the distributions to use, performance controls for interim periods, and management techniques to invoke when markets become turbulent.

Climate change forces risk professionals to be proactive instead of reactive. Sitting back and just monitoring periodic risks is not enough anymore. This involves a lot of adjustment.

Risk professionals’ first adjustment will be alerting executives and board directors that climate-informed investing affects their work. These conversations are past due in general for long-term investors, but they have been prohibitively difficult until now because of career risk. Complicating matters further is the tendency of risk managers to behave conservatively, to often find safety in numbers, and favour the status quo. Climate change gives risk professionals cover for telling executives and directors that status-quo risk metrics and methods are too short-term in focus.

After resetting leaders’ expectations in this way, risk professionals’ next adjustments will be the technical work:

All of this change will culminate in a third adjustment in which risk professionals, executives, and board directors stress test this new risk management model against turbulent scenarios that reflect possible regime change in climate regulation and/or organisational responsibilities.

Instead of directors and risk managers talking past each other and defaulting to the status-quo, climate change has the potential to be a common language both parties share, the unstoppable force altering the previously-immovable object of investment risk methods circa the 1950s.

This will be as hard and uncomfortable as it sounds. Chris Goolgasian, director of climate research at Wellington, gave a hint of it in a webinar that FCLTGlobal hosted last fall about climate and investment risk.

“We’ve got a hundred years of history” for many established factors, Goolgasian observed. He continued, “There’s no such thing for climate change… what I recommend is that we use forward-looking projections essentially for the first time in our industry.”

By estimating the future instead of just measuring the past, risk managers will own the beliefs and strategies that underpin their projections, proactively working together with boards and management teams to tackle a common threat, rather than passively reporting to them. All of this change will have one existential benefit: investors will get into position for meeting net zero and other sustainability commitments in the long run.

Risk managers can also enjoy another tidbit of good news: they will not be alone amidst this change.

All the standard functions within an investment organisation will have to change. Lawyers will use different deal terms. Strategic communications teams will engage differently with stakeholders. Human resources will have different skills matrices for recruiting and retaining staff. Executives and directors will engage differently with one another. And investors will construct portfolios differently.

Adapting risk management is necessary for an investor to respond to climate change. But it takes all these changes combined for that response to become sufficient.

What happens when an unstoppable force meets an immovable object has been a riddle until now. In investment terms, we have the answer. Traditions, like those of risk management, only look immovable. They must – and will – move to the force of climate trends.

Allen He and Matthew Leatherman are co-authors of “Balancing Act: Managing Risk across Multiple Time Horizons” and subsequent research about investment risk for FCLTGlobal.

ADIA is increasing its focus on renewables and digital infrastructure as its infrastructure investments mature and a more sector-led strategy is introduced into the planning process according to Karim Mourad, global head of infrastructure at ADIA.

ADIA has been investing in infrastructure since 2008 and has a portfolio across all major sub-sectors and regions with a strategic allocation of up to 5 per cent of the fund.

In the past it has focused on detailed, bottom-up deal assessment but a new focus on sector-led analysis as part of the overall strategy of the fund has meant a more purposeful focus increasing exposures to some growth sub sectors including renewables and digital infrastructure.

It also means fewer but larger acquisitions and managing the overall number of positions, he says.

While some sectors such as passenger-linked transport assets were challenged last year, others including digital infrastructure and renewables experienced a stand-out year.

“We were an early mover in renewables. We recognised the opportunity for a long-term investor to back strong companies such as Renew and Greenko in India as they developed new technologies and new markets,” he says. “Looking ahead, we expect renewables will continue to grow their proportion of global energy capacity, supported by strong tailwinds from the flow of capital into the sector from ESG- focused funds. We have made investments in the USA, Europe, India, and developed Asia, in companies that are at different stages of maturity, and we remain a keen investor in the sector.”

Mourad says the fund is working on various initiatives associated with energy transition more broadly and expects that to be a key area of focus in the near-to medium-term.

In addition the demand for digital infrastructure is only going to grow, he says, and these assets offer a source of diversification uncorrelated to more traditional transport or energy assets.

“Over the past few years, we have built our relationships, capabilities and asset portfolio in the sector, and we have exposure to fiber investments in the USA, Europe and India, exposure to towers across Europe and APAC, and have made inroads into data centers through listed investments. We expect to use the full playbook of strategies to access opportunities in this dynamic and growing sector,” he says.

In July this year ADIA invested $500 million in what is a significant minority stake in EdgePoint Infrastructure, a digital infrastructure platform focused on developing, acquiring and operating telecommunication towers, distributed antenna systems and adjacent infrastructure in Southeast Asia.

Meanwhile Mourad says the benefits of predicable, stable cash flows means core infrastructure remains attractive and the fund will continue to invest in transport and utilities.

In 2020 the fund deployed more capital in infrastructure than any other year including three investments made in listed infrastructure in the last quarter. The listed universe remains an area where the team will focus and look for dislocated or relative value opportunities, Mourad says.

An example of the fund’s approach to infrastructure across both listed and unlisted is its investment in WestConnex in Sydney, Australia. Alongside AustralianSuper, CPPIB and Transurban it holds 51 per cent in the motorway network, WestConnex, and it also participated in Transurban’s equity raising on the Australian Securities Exchange.

“Our listed programme also means we can support key corporates with whom we have strong relationships on strategic transactions where they need to raise capital. This will continue to be important given our ongoing focus on larger, more strategic investments alongside other investors,” Mourad says.

The fund is looking to grow its infrastructure team and is actively recruiting.