Investors should start factoring in the importance of a just transition to a low-carbon economy, said Bettina Reinboth, head of social issues at Principles for Responsible Investment (PRI).

Speaking at the PRI’s Climate Forum in London, Reinboth called for investors and governments implementing broader climate change strategies to engage with workers, communities and businesses to better support and re-skill stranded workers.

Investors can begin to emphasise the importance of a just transition, part of the Paris Agreement, in their investment strategy through beliefs and mandates – raising it in their engagement processes with companies and in their capital allocation. She also urged investors to use their weight at a policy level to influence government debate.

Workers in the extractive industries, transport sectors and the gig economy – populated by freelance workers on short-term contracts – are most at risk of disruption amid a shift to a low-carbon world. Yet, progress on climate change and workers’ human rights remain separate, Reinboth said.

The human face of climate change

“We need to unify climate change with the social dimension,” she said. “In delivering the upside via green jobs, we need to avoid the downside of stranded workers and communities. Closing a mining site is good for carbon emissions, but what happens to the people relying on these jobs, on re-skilling them, and the ancillary services that are also effected?”

The PRI will officially launch a co-written report on the just transition at the 24th Conference of the Parties to the United Nations Framework Convention on Climate Change. COP24 began earlier this month in Poland.

“Poland is coal-dependent, so it is a fitting venue for launch,” said Reinboth. The International Trade Union Federation, the Grantham Research Institute and the Initiative for Responsible Investment contributed to the report.

Climate migrants

Trade unions are vital partners in the transition to a low carbon world, said Jason Mitchell, Man Group’s co-head of responsible investment. Taking Germany as an example, he told forum delegates that unions have a profound influence on local and federal climate policy. Germany has committed to phase out coal power generation by 2030 but this will only happen with union support, he said.

“The importance of the social dimension has become very clear to us in a number of areas,” Mitchell said. “Trying to understand it is integral.”

An unjust transition is already manifesting in some parts of the world with real investor risk, noted Mitchell, who has just completed a study of the impact of migration on financial markets, looking at climate migrants within the broader migration flows into Europe.

His research examines how population loss in some African economies will impact the long-term GDP of these countries and the risk this poses for holders of African sovereign debt.

There is an opportunity for long-term investors to team up with corporates to actively shift the dial in the focus around the short term, according to Chris Ailman, chief investment officer of the $219 billion California State Teachers’ Retirement System (CalSTRS).

Speaking at the Sustainability Accounting Standards Board (SASB)annual conference in New York this week, Ailman suggested investors and corporates collaborating to end the focus on 90-day results could be beneficial.

“Are we obsessed in America with the short term? Heavens yes, it’s horrible,” Ailman says.

“Our country cares more about what the president tweeted this morning than they do about what happened in the last 20 or 30 years – that doesn’t matter. This is one area where, as long-term investors, we could team up with the Chamber of Commerce or Business Roundtable.”

He suggested changing the 90-day corporate results briefing with investors to be a conversation with just the CFO about the facts, and then have management talk about the long term.

“The long term doesn’t change every single 90 days, and management could reinforce that point like a drum beat, and emphasise that they think long term,” he says.

“I’m slow money, long-term patient capital – I shouldn’t care about the short term. We need to find one way to work together and turn this around.”

 Ailman says California teachers had one of the longest life spans in America, and CalSTRS currently has 350 retirees who are more than 100 years old receiving benefits from the pension fund.

“I say to directors of companies, ‘As long as there are public school teachers in California, we will own your stock, which will be long after you’re on the board’,” says Ailman, who has been CIO of the pension fund giant since 2000, the longest-serving CIO in CalSTRS 105-year history.

E, S and G

Ailman was on a panel with Hans Op ‘t Veld, head of responsible investment at PGGM, who says companies seem to be more interested in the incremental buyer and seller than the long-term investor “which is a bit strange”.

In the case of PGGM, which manages around $250 billion, integrating ESG is a tool to help understand the companies they invest in and “tweak what is not right”.

“We are the providers of capital, not the CEO or the people running the company, so you can’t overstep your boundaries and make real changes. But we do have responsibilities as stewards of capital to understand why it is an acceptable investment,” he says.

At CalSTRS, Ailman said ESG is engrained in the culture and E, S and G are separately listed as risk factors in its investment policy.

“Every investment policy references back to our risk factors; it’s engrained in everything we do. We have an E, S and G team, and you will be seeing a comprehensive effort from us in all parts of the portfolio,” he says.

In terms of working with external investment managers, both investors said they wanted to make sure ESG integration was not a tick-the-box exercise.

“When we survey managers, about 97 per cent say they do integrate ESG. But our board wants us to go the extra step to say, ‘How? Prove it. Show us.’ We’ve seen managers where the ESG team is in a small building across the street and their badges don’t allow them access to the trade desk. That’s not what we are talking about,” Ailman says.

 

Need for a common language

Op ‘t Veld says it is not a question of yes or no when it comes to ESG integration.

“We see all the time fantastic frameworks, screens and numbers and, for the manager, it all works, but then we ask them if they back-test whether it works or not, and it becomes quiet,” he says.

“With managers you can’t ask the question of whether it’s yes or no. It’s more important to ask, ‘Are they involved in the decision making and to what extent is it based on data?’”

But Ailman also pointed out that some of CalSTRS existing managers are looking at long-term business risks – such as workforce turnover, harassment claims or how they deal with waste disposal – but they don’t label it ESG.

“A lot of time the credit, value and private equity managers look at these things but they don’t talk about them as ESG. They talk about them as long-term business risks. And I think that’s where we need to pay attention on whether they are focusing on things we care about. This is why I like SASB so much because it gives me something material to focus on, a framework to work with.”

Similarly at PGGM, Op ‘t Veld says there needs to be a common language.

“There has been an issue in the past where we felt we had silos, our credit guys do due diligence and listed real estate guys do due diligence and amass a wealth of knowledge but look at it slightly differently in terms of language. This is where SASB comes in to link that up and holistically look at it.”

Moderating the session, Anne Sheehan, who was a former staff member at CalSTRS, original board member of SASB, and is now chair of the SEC investor advisory committee, said the SASB materiality mapis a helpful visual. It’s an interactive tool that helps identify and compare disclosure topics across different industries and sectors.

Ailman is chair of SASB’s investor advisory group, which this year had a goal to reach out to 50 companies. It now has 30 companies signed up to use its matrix. SASB has $26 trillion in investor support including asset owners and asset managers.

The £30 billion ($38 billion) Brunel Pension Partnership, the asset pool comprising 10 of the United Kingdom’s local authority pension schemes, is finding significant investment opportunities in private-sector renewables infrastructure.

Speaking at the Principles for Responsible Investment (PRI) Climate Forum, Faith Ward, chief responsible investment officer at Brunel Pension Partnership, referenced “huge deals” and “good quality opportunities” in a strategy which deliberately tilts the infrastructure portfolio towards renewables via global mandates but with an emphasis on the US and Northern Europe.  She noted that the pension fund wasn’t “paying over the odds” despite high prices in private markets and said it would rather not allocate than overpay.

Integrating climate strategy has been a top priority at the new asset manager. The fund is “100 per cent climate aware,” with climate risk integrated across all asset classes. The fund has also introduced a low-carbon index for part of its passive equity portfolio and is looking to create its own carbon metrics to allow clients funds to improve their level of knowledge and encourage strategic decision making.

Rather than divest, Ward runs a nuanced strategy that subtly identifies companies transitioning to a low-carbon economy, frequently drawing on expertise from the Transition Pathway Initiative (TPI) the free, point-of-use tool which assesses companies’ preparedness for the transition, and of which she is co-chair. Ward also noted a prevalence of forward-looking managers with strong due diligence.

“There are a range of fund managers in this space who are very good at recognising low carbon is a good opportunity and a good investment,” she said.

 

Tough obstacles require tougher due diligence

Under Ward’s leadership, Brunel is carving the same reputation for tough manager due diligence and screening out greenwashing pioneered by the Environment Agency Pension Fund, now under the Brunel umbrella.

“It’s a case of drilling down and seeing if what the managers are promising is demonstrable,” she said.

She added that the process of “kicking the tyres” should be fully integrated into manager meetings – from discussing the investment process and risk parameters to fees. It should also be within the remit of all members of the investment team rather than the preserve of the responsible investment team.

“If carbon outcomes are part of a manager’s pitch, they need to be sure what you are talking about because we will pull them out and it can be painful.”

Obstacles to investing in low-carbon strategies include a lack of data, said Meryam Omi, head of sustainability and responsible investment strategy at Legal & General Investment Management.

Although the data aren’t perfect, she said there were enough for asset owners to invest in low-carbon strategies in the equity and bond spaces, adding listed equity is “a good place to start”.

 

An elevated conversation

Omi said active strategies could focus on low-carbon integration by stock picking new technologies – or on asset classes such as infrastructure. She warned that investors wishing to benchmark against a main index need “an elevated conversation” regarding what they are benchmarking against to ensure the index is aligned as closely as possible to Paris Agreement goals.

Low-carbon strategies should also be nuanced. For example, divesting from utilities because they use coal could mean cutting out exposure to utilities that are also investing in renewables. She also cautioned against an “obsession” with divesting and reducing exposure to carbon. She noted that this strategy can lead to investing more in other sectors like banks, many of which are financing fossil fuels.

Omi also urged investors to look at how their managers are voting and what they are saying on the big topics.

“A lot of clients don’t dig through” to see how their managers vote and hold companies to account, she said.

CCLA Investment Management, which manages £8 billion ($10 billion) on behalf of the UK’s church and charity sector, has prioritised a reduced exposure to coal as part of its low-carbon strategy. It has signed up to the UK government’s Powering Past Coal Alliance where strategy includes engagement with many of the US and European utilities it holds in its portfolio.

CCLA looks at how these companies are managing the transition, avoids companies that are allocating capital to coal and works with utilities to phase out coal power over time, explained Helen Wildsmith, stewardship director, climate change, CCLA. She also noted companies in the sector are increasingly working together in industry groups to tackle climate change.

 

The Task Force on Climate-related Financial Disclosures’ (TCFD) recommendations for a standardised reporting framework are gaining traction with over 500 organisations now officially supporting the voluntary scheme for companies and investors to report climate-related information in their financial holdings.

TCFD, which was set up in 2015, involves a long, often challenging, process of integration that can span three years or more.

Speaking at the Principles for Responsible Investment’s Climate Forum in London, Jennifer Anderson, investment officer for the United Kingdom’s £10 billion ($12.77 billion) TPT Retirement Solutions, formerly the Pensions Trust, explained the pension fund’s progress and challenges on its TCFD journey.

Firstly, TPT defined its climate beliefs and placed oversight of climate change strategy with its investment committee. The fund also publicly committed to reporting in line with the recommendations set out by TCFD and to reviewing its climate strategy on an annual basis. Anderson credits the enthusiastic approach to TPT’s enlightened trustee leadership which began looking at climate change back in 2011.

In a second step which involved working with Mercer and other experts, TPT began to look at how it would integrate climate change into its investment strategy across different asset classes.

A third pillar has involved integrating climate change into the fund’s risk management processes. Limited internal resources and evolving risk metrics have made this element of TCFD compliance the most challenging, said Anderson. Translating data into risk metrics that can be presented in a way the trustee board understands, particularly around the impact on funding values, is difficult. In addition, using the various tools on offer has been costly and, therefore, unsuitable for regular use.

“We need to run analysis ourselves as part of portfolio management systems,” she said.

Anderson also noted challenges around the TCFD’s target setting requirements and a lack of clarity around what characterises a “meaningful target.” Moreover, the fact that TCFD reporting is voluntary, and not backed by regulation, has contributed to lacklustre member interest and engagement in the process. “We are committed to report in line with recommendations but who is it for,” she asked.

A hallmark of the TCFD’s disclosure framework is the recommendation that organisations provide climate-related financial disclosures in their main annual financial filings, and that companies treat the reporting of climate-related issues in the same way as any other material information. Yet, Anderson noted that positioning the long, detailed report within the pension fund’s annual report and accounts puts climate risk “out of kilter” with other risks. However, partnering with other asset owners and closely working with the fund’s asset managers has proved essential to the process, she said. All TPT management is outsourced and assets are split between a liability-matching allocation (40 per cent) and a growth allocation (60 per cent). The growth allocation is divided into five sub-portfolios, and equity accounts for around a quarter of the growth allocation.

Hermes, the asset manager with £33 billion ($42 billion) under management and a global reputation for ESG, works with investee companies to align their disclosure practices with TCFD recommendations.

Hermes has an engagement team of 25 to 30 people within which different groups set targets on engagement, said Christine Chow, director at Hermes Equity Ownership Services (EOS). In an important milestone, earlier this year the asset manager ran a workshop for China’s oil and gas giant Sinopec on TCFD recommendations and discussed how the company could analyse its portfolio resilience to a number of relevant low-carbon scenarios. Hermes reports the carbon footprint of around 90 per cent of its AUM; the asset manager has also recently developed a carbon tool to better understand concentration of carbon emissions, rather than use a third-party tool, she said.

Indeed, tools and the ability to access the information needed to incorporate TCFD recommendations and navigate the energy transition is a shared challenge for investors; a key TCFD recommendation asks for forward-looking analysis to assess how investors’ exposure to climate change-related risks and opportunities might impact on portfolio performance over time.

One of the latest tools on the market is the free-to-use, online PACTA tool developed by the 2⁰ Investing Initiative for assessing climate-transition risk in equity and bond portfolios. Significantly, the tool allows investors to see the gap between their existing portfolio and two-degree benchmarks, explained Clare Murray, an analyst at 2⁰ Investing. The tool focuses on the power, coal mining, oil and gas and auto sectors, responsible for 80-90 percent of carbon emissions from listed equity markets, she said.

Softer issues around the expectations an asset owner has of its service providers are difficult to measure and monitor. Expectations such as acting with integrity, good levels of communication, and the evolution of organisational structure are all important aspects of an asset owner/manager relationship, yet are not typical in investment management agreements.

Now, in a bid to promote long-term relationships with its managers, Brunel Pension Partnership, the £30 billion ($38 billion) collective of 10 like-minded UK local government pension schemes, has developed the Brunel Asset Management Accord for its managers.

The accord is a document, jointly signed by an appointed manager and Brunel CIO Mark Mansley, that outlines expectations around the partnership.

The accord states that it is intended to help clarify understanding and shape expectations in the implementation of the investment mandate that Brunel has awarded to the manager.

It’s a document expected to assist in the promotion of integrity and better alignment between the manager and Brunel, especially with regard to goals and time horizons.

“The aim of the accord is to capture not only our expectations of managers, but also the spirit of what they can expect from us,” Mansley says. “The idea is that by putting this document together, we can address managers’ key concerns and help managers understand what matters to us.

“It’s a proactive approach intended to equip managers to work with us more collaboratively and focus our dialogue with managers on the really important issues.”

In the accord, Brunel outlines its expectations under five main criteria: being long term; communication is vital; responsible investment and stewardship; collaboration; and thought leadership and innovation.

Being long term gets the most attention in the accord but expectations in that area are not limited to the asset manager’s actions. While the pension organisation states that it expects performance over the medium to long term and that the relationship will last several years, possibly a decade, it also addresses Brunel’s own actions in the monitoring of managers. The accord states that “investment performance, particularly in the short term, will be of limited significance in evaluating the manager”.

While Brunel typically expects its mandates to prove themselves in three years, and does terminate them with good reason, it expects some mandates to be in place for 10 years or more. It wants managers to be aware that appointing new managers is resource intensive and not something Brunel would do lightly.

The accord was developed in consultation with Brunel’s chief responsible investment officer, Faith Ward, who says it is intended as an opportunity for clarity and openness on both sides, with the aim of making manager relationships a true partnership.

“We hope that by spelling out our expectations, [we will make] asset managers feel safer and do better,” Ward says. “We believe that this documented approach is groundbreaking in the investment industry and hope that others will follow our lead. In the long term, more co-operative and transparent relationships will have better results for us all.”

It is clear we are going to have to deal with artificial intelligence and its various effects on our industry and wider economy.

To label something artificial implies that we know what’s real. What is real intelligence? Do we mean human intelligence? And if we do, does that mean crows, chimps and dolphins are not intelligent? Or is intelligence something bigger and more abstract, such as evolved, cultural intelligence?

This latter thought hints at a difference between the individual and the collective: an ant or a bee may not clear my hurdle for intelligence, but an ant colony and a bee swarm would. Having decided what the real thing is, can we articulate an adequate definition of it?

The label ‘artificial’ may also send us towards an unnecessary dead end. What if the future real thing is some combination of natural and artificial? Or, what if artificial becomes the real thing? We will let that particular thought drop for now.

As for defining intelligence, I defer to David Krakauer, president of the Santa Fe Institute, who says it means “making hard problems easy”.

Krakauer has also defined stupidity as “making easy things hard”. I like these definitions for a number of reasons; they are short and use short words, they apply to both biological neurons and printed circuits and they give wide scope for exploration.

I have already suggested above that culture could be a form of intelligence – by laying down behavioural rules, or norms if you prefer, culture can make hard problems easy by showing us how to behave or exercise choice in a given situation.

So it seems that there are multiple forms of intelligence, not all of which are obvious under casual observation. What about embodied intelligence (morphological computation)? It is possible to build a purely mechanical machine, based on human geometry (with a pelvis and two legs), that will walk on a treadmill, suggesting that evolution has found a design that can perform a sophisticated function without the need for external computation. Or consider the performance of top athletes, who make hard things look effortless. We could call it skill, or we could call it movement intelligence. Essentially, their hours of training can be thought of as creating a set of reflexes that fire with precise timing to achieve the desired result. But movement intelligence may require language intelligence, which is conjecture advanced by John Krakauer (David’s brother) of Johns Hopkins University. The top athlete has a coach providing language-based instruction. There are no videos of monkeys juggling on YouTube, so perhaps the movement intelligence behind juggling can be learned only through language – by being told what to do.

Going back to reflexes, they are by definition involuntary. They are too fast for us to be able to think about them; therefore, they can show us the limits of knowledge. Experiments have shown that you can give subjects the necessary knowledge – that the handlebars of a bicycle have been reversed, for example – but it is of no use to them. Apparently, it still takes months to retrain bike-riding reflexes. All very interesting, but we should get back on track. I would like to return to the thought I dropped earlier, about combining natural intelligence (whatever that is) and artificial intelligence (whatever that is).

If you subscribe to the Pablo Picasso school of thought – “computers are useless, they can only give you answers” – then, in effect, you believe in the cognitive outsourcing model. Under this model, we give computation problems to a computer on the basis that it can perform them faster, cheaper, and probably more accurately than we can, just like in any good outsourcing arrangement. Nothing much of interest is implied by this model. There is no transformative leap in our human intelligence, just some solid productivity improvements. This is possibly why AI can be viewed as threatening. As the machines advance faster than we can, what if they start to know things that we don’t?

An alternative model is available, however – the cognitive transformation model. This states that as we internalise new cognitive technologies, we change the range of thoughts we can think. So computers, under this model, become a medium for expanding and spreading cognitive technologies. AI then becomes less threatening, as it can be viewed as offering us more powerful cognitive technologies that we will internalise in time – giving us more powerful ways of thinking (and allowing us to design more powerful AI, and so on). Now that would be real intelligence.

To me, the cognitive transformation model offers optimism and hope as an alternative to the dark march towards the technological singularity (the point at which machines can design better machines than us and therefore take charge); therefore I would like to believe it’s true. But hope is not a strategy. And the extraordinary pace of development in AI makes understanding intelligence a practical question. The good news is that there are many bright minds studying intelligence in academia. The bad news, David Krakauer says, is that stupidity is the single biggest threat to mankind – and no one is studying that.

 

Tim Hodgson is head of Thinking Ahead Group, an independent research team at Willis Towers Watson and executive to the Thinking Ahead Institute.