The world is shifting from having very few centralised power stations feeding electricity into the grid, to a more dynamic market with abundant opportunities for investors, according to Alex Brierley, co-head, Octopus Energy Generation, a specialist renewable energy and energy transition manager with about £6 billion worth of assets under management.

The opportunity set now includes rooftop solar generation, the decarbonisation of heat, energy storage and electric vehicle charging, green hydrogen and many other facets, Brierley said, in a panel session at the Sustainability in Practice forum, organised by Top1000funds.com and held at Oxford University.

“These are big new investment areas that I think investors should engage with,” Brierley said, in a session looking at the European energy market over the past three years and the opportunities in renewable energy assets.

Energy investors are looking for diversification and low correlation with their listed equities and fixed income portfolios, along with predictable yield and inflation protection, when they look to infrastructure including renewable energy infrastructure, Brierley said.

These expectations have been tested over the last three years, with events such as the onset of Covid-19 and the invasion of Ukraine causing massive fluctuations in energy and commodities prices. Now the fighting in Gaza threatens the path of oil and gas into Asia if Iran moves to shut the Strait of Hormuz. 

Despite the turmoil, renewable assets have largely performed as investors hoped, “and that I hope encourages many investors in this room to keep on investing in the incredibly important job that these assets are doing,” Brierley said.

Green hydrogen is unlikely to play a part in decarbonising heating in homes through the existing gas network, as ground source and air source heat pumps are far more efficient, and less dangerous, Brierley said. However green hydrogen could play a role in decarbonising big industry, he said. 

Green hydrogen is also the likely answer to power storage in a world dominated by solar and wind assets, he said, as “when there’s low wind for four or five weeks in a cold winter, short-term batteries just can’t cut it.”

Increasingly engaged consumers are also playing a role by buying electric vehicles at scale, plugging them in, and “allowing power companies like ours to actually determine when to charge those vehicles or not to charge those vehicles,” he said.

“We now have about 100,000 electric vehicles under the control of Octopus, we decide when they charge and when they discharge,” Brierley said. “What that essentially means is that we have about 550 megawatts of dispatchable capacity, which is basically just a really, really big battery and it’s extremely efficient.”

A table discussion asked audience participants–predominantly global institutional asset owners–what was holding them back from further investment in the energy transition, drawing a range of varied responses.

One participant said the rise in interest rates, and corresponding cash flow management issues,  had reduced demand for higher-yielding, illiquid infrastructure assets. Others were concerned about the economic sustainability of some parts of the renewable energy ecosystem with some major players in wind generation experiencing problems. 

Another investor said there were bigger priorities than the energy transition, such as water security. Another pointed to the difficulty of portfolio design with climate opportunities often falling between different asset classes, and challenges building internal expertise to recognise and move on opportunities.

Modern portfolio theory is useful in a world where the future is just like the past. But when it comes to climate change, the future is likely to be dramatically different requiring a new framework for decision-useful climate scenarios.

Speaking at Sustainability in Practice at Oxford University, Mark Cliffe, Visiting Fellow at Global Systems Institute, University of Exeter said that long-term scenarios looking years into the future are not necessarily decision-useful. They don’t reflect the volatility ahead and official scenarios underestimate the risk and opportunities arising from climate change, he told delegates, adding the challenge of pricing and modelling portfolio risk is finding predictable activity.

Cliffe explained that key “chronic” risk analysis is missing in modern portfolio scenarios which omit, for example, the impact of tipping points, natural capital loss, and the impact of war.

Scenario drivers include policy, geopolitics, the state of economies and technological change. “You have to factor this into scenarios,” he told the audience of institutional investors, asset managers and fellow academics. Elsewhere, he warned that the actions of NGOs and shareholders also needs to be integrated into a base for transition planning.

The challenge for investors is finding a balance that integrates the financial materiality in line with these risks and a fiduciary duty and legal obligation to reduce risk. However, he said “investors don’t have legal obligations to the planet.” Engagement is a high impact strategy and it is possible for investors to pressure companies to take responsibility for their externalities although he said “persuading people to do things they don’t want to do is hard work.”

He noted that divestment allows investors to hit carbon targets by offloading assets but “doesn’t help the world.” Alternatively, investors can line their portfolios with transition assets, and ride the transition.

Fellow panellist Mirko Cardinale, head of investment strategy at USS, explained how the United Kingdom’s largest pension fund has introduced a new approach to climate analysis. Traditional scenario analysis, he said, often left the investor with more questions than answers and omits uncertainty around physical risk and the interaction between physical risk, inflation and tipping points. [See USS outlines new  climate scenarios for improved investment decision making.]

The investor has focused its analysis on key objectives including the integration of climate science; a focus on short-term scenarios in a bid to make the information decision-useful, a focus on volatility, moving away from benchmark-relative to holistic performance assessment and introducing a new governance framework. Cardinale said it involves a change of mindset in terms of how to approach asset allocation.

“It’s much harder to incorporate this complexity into portfolio,” he said.

Cardinale explained that the approach involves embracing a multi-faceted view of risk and moving away from strategic asset allocation with clearly defined parameters and reference portfolios.

He said that at USS the process remains a work in progress. “We don’t have firm conclusions and can’t say which assets to buy and sell.”

Going forward, the process will help shape scenarios that include new, challenging views on assets that will inform and change the nature of mandates and set different asset allocations. He continued that analysis involves quantitative and qualitative assessments.

“You need a process that has the flexibility to be top down and bottom up, allowing the different design of mandates for equity and infrastructure.” He added: “factoring in resilience to climate and inflation may be more important than the change in asset allocation.”

He said that climate is a clear financial risk and doesn’t conflict with fiduciary duty and told delegates that USS has been able to explore this new approach because of a change in governance.

Fellow panellist Mike Clark, founder of Ario Advisory and the Institute and Faculty of Actuaries representative on the global advisory council of the Sustainable Finance Programme at the University of Oxford’s Smith School of Enterprise and the Environment said it is important to get finance closer to science.

He said that the strategic risk around climate is mispriced; investors are not managing systemic risk or engaging with policy makers. He added that modern portfolio theory doesn’t work because of explosive materiality – for example changes in the food system and different growing seasons in Europe.

“There are things out there that finance isn’t thinking about, we are approaching tipping points and how are we going to reprice risk?”

 

The world is on the cusp of entering a new labour market. As western economies grapple with demographic shifts and labour mismatches, a new set of opportunities and risks have appeared for investors. PGIM thematic research group director Jakob Wilhelmus outlines what they should look out for in this new world order.

The world is on the cusp off entering a new labour market as western economies grapple with demographic shifts – ageing populations, shrinking workforces, labour mismatches and the rise of new technology.

Dealing with the first issue, many countries continue to treat Japan as the classic case study of dealing with an ageing workforce. However, investors have been warned that the country’s macroeconomic experience was, in fact, an “outlier”.

In a podcast interview for Top1000funds.com, Jakob Wilhelmus, PGIM’s thematic research group director, said he’s concerned that Japan has become a “distraction” for investors.

His latest Megatrend research paper, The Transformation of Labour Markets, identified declining working-age population and labour mismatches as two main elements behind the world’s changing workforce. For most countries, Wilhelmus said these two factors would mean higher inflationary pressures, which was not the case in Japan.

“There are really two reasons for that [increasing inflationary pressures]. One is the fact that a decrease in available workers will increase wages, which in turn will lead to higher price inflation,” he said.

“And second… the growth of that [retiree] segment of society will lead to more consumption, higher fiscal spending and less production.

“This was very unlike the experience that Japan had two-three decades ago, and that is because it took choices that maximised the disinflationary impact by deciding against immigration, and instead started to outsource its production.

“But when you look at the realities of today, countries are facing a very different situation where labour is becoming scarce almost everywhere.”

Industries on notice

Labour mismatch refers to the structural imbalance between labour demand and supply and, according to Wilhelmus, often gets mistaken as short-term cyclical shortages.

He pointed to the example of China, the country with the most STEM graduates in the world. Despite abundant talents, the country’s youth unemployment rate is over 20 per cent in 2023. Wilhelmus attributed the phenomenon to a discrepancy between China’s main economic activity (manufacturing) and its worker’s sophisticated skills.

“The situation is very similar here in the US, Australia or Europe. There is a big gap between the demands of the job market and the skills the workforce possesses or can offer. In certain advanced economies, it’s particularly around vocational jobs like nurses and electricians.”

When it comes to potential solutions for the mismatch, Wilhelmus said policy choices will play an important part.

“On the one hand, it is immigration, which is a very loaded topic. But realistically, almost every country will have to figure out how to track global talent in a world where most countries will be competing for the same pool.

“On the other hand, its participation rates… because the reality is that while many countries have come a long way, the female participation rate is too low, and finding ways to increase that can increase economic output significantly.”

Investors’ role

The lesson for investors from these insights, Wilhelmus said, is to think twice before buying into the new labour market’s hype, of which generative AI is a prime example.

“It’s in some way very similar to the early days of the internet. AOL and Netscape looked like earlier winners, but those are two names that few investors want to remember,” he said.

“It’s really about the infrastructure to run those services and the underlying models, and not so much about the applications. That means investments in data centres – both the providers and the actual real estate – as well as chip manufacturers.”

He also suggested that investors based their analysis more on countries, and less on asset classes. As countries face different demographic stages, they will have different growth rates.

While advanced economies are already struggling with inflationary pressures, emerging markets such as Asia and Latin America may be less threatened, while South Asia and Sub-Saharan Africa regions are just seeing the benefits of a young and growing population.

“But here the challenge is that demographics alone do not guarantee economic growth… because most of the countries in those latter two regions really lacked the high levels of human capital and institutions that are needed to unlock the economic prosperity that can come from a growing workforce.

“It is really about a holistic assessment of the turning point in global labour markets and working through all of its implications.”

Investors should be “asset class agnostic” when it comes to impact investing and can’t afford to neglect the fixed income market, according to Oyin Oduya, impact measurement and management practice leader at asset manager Wellington Management. However she told investors at the Sustainability in Practice event at Oxford University last week they should approach labeled bonds with a critical lens due to risks of greenwashing.

S&P Global Ratings predicted in September that green, social, sustainable, and sustainability-linked bonds (GSSSB) will account for 14 to 16 per cent of total bond issuance in 2023. The asset category is forecast to have $900 billion to $1 trillion worth of issuance for the whole year, with green bonds expected to account for 59 per cent of the total GSSSB.

Oduya highlighted that labeled bonds are fundamentally “based on promises” before they are issued. While bond issuers will usually tout regular allocation reports and strong investment frameworks, there are risks that the promises will not be fulfilled in the long-term.

But there’s also the issue created by the independence between the bond and the issuer. “You could have a bond, which is doing something good, issued by an issuer that’s doing something bad,” she said. These are exactly the reasons why Wellington doesn’t focus exclusively on labeled bond, despite their obvious appeal. In fact, the asset category is currently a minority in its global impact bond portfolio.

She suggested that investors stay clear headed on labeled bonds by examining revenue materiality (Wellington’s benchmark for labelled bonds is 90 per cent of use of proceeds going to impact themes), additionality (where the enterprise itself is doing additional works) and measurability (a defined KPI at the time of investing).

According to the Global Impact Investing Network (GIIN), the impact investing market stands just above $1 trillion, a drop in the bucket compared to $100 trillion in global assets under management.

In terms of choosing between public and private assets, Oduya suggested investors note the differences in measurement such as data availability. For example, private markets tend to have scarce data due to a lack of sustainability departments or staff, and investors have to do the work in encouraging them to develop relevant disclosure. But the public markets’ problem can be the exact opposite, because public companies tend to have significantly more resources and an abundance (or an excess) of data.

“Once the money has been invested, the issue we have in public markets is that they are very good at giving you ESG data,” she said. “They’ll be able to give you scope one or two emissions, numbers about the diversity of their board, and how many volunteer days they’ve done that year. But they can’t tell you where their product is being used, how much GHG emissions are being avoided, or how many people are getting access to health care at an affordable cost.”

Oduya conceded that for impact investing to become really institutionalised, investors need to set their sights beyond alternatives to the entire capital markets and recognise that investment performance will be absolutely crucial.

“I’m saddened, but it does come up in meetings where people ask: ‘If you’re an impact fund, does that mean it’s a concessionary strategy? Do you think that if a company has more impact, you can put it in the portfolio even if it has a less attractive financial return?’

“The answer is always we have to have both attractive financial returns and positive impact. It doesn’t make sense for us to have a portfolio which is concessional, but you want to be able to grow, scale and attract investors. Impact is not sustainable in this framework, if it doesn’t make money.”

ESG-momentum matters when it comes to outperformance according to new research by Pictet Asset Management’s head of sustainability Eric Borremans who says investors should sharpen their ESG lens and use active ownership to trigger positive change.

Speaking at Sustainability in Practice at Oxford University he highlighted the new research from the Switzerland-based investor that examines the performance attribution of conventional and ESG indices over long time horizons revealing the importance of governance and engagement.

Borremans said that risk-adjusted returns from ESG fixed income indices are in-line with wider market returns. “That’s good news as it means that investors can build portfolios with stronger ESG credentials without losing money.”

He added that the green economy has had ups and downs but the overall picture remains positive as the sector continues to benefit from supportive policy measures such as the IRA. “Since 2018, companies that derive more than half of their revenue from the green economy, as represented through the FTSE ET 100, have generated superior risk-adjusted returns,” he said.

Still, he noted that the hike in interest rates has had a negative impact on renewable energy projects, contributing to delays and cancellations in offshore wind while other challenges include the outside position of some companies in green indices.

Despite positive returns, Borremans said that investors still question the ESG ratings that underpin the construction of indices with many concerned about the extent to which ratings are a good lens to anticipate investment risks and opportunities.

In 2018 Pictet sharpened its own ESG lens, developing smarter ways to analyse companies that included focusing more on corporate governance. The firm’s analysis explored whether governance was “functional or dysfunctional,” analysed companies’ products and services; operations risk, ESG objectives and whether the footprint it left behind was generated at the expense of society and the environment.

“We asked if the company was facing liabilities because of mismanagement,” he said.

Pictet applied its key questions to thousands of companies and then aggregated the results together. A challenging process that had to unpick multiple issues. “For example, we thought that a weakness in one area could be compensated by strength in another but decided that each issue needed to be looked at in its own right to find outliers.”

The analysis also explored momentum, looking particularly at corporate progress over a 12-month period. It can take years for companies to meaningfully change their products, but governance and the change it can bring can happen quicker, he said. “We found more often than not that incremental changes were triggered by governance.”

Companies with a positive momentum outperformed (about 1 per cent per annum) the universe with lower levels of volatility. In contrast companies with negative momentum underperformed the index (around 1 per cent per annum) with higher volatility. “We came to two conclusions. ESG momentum matters and investors should monitor corporate governance as a key driver to momentum.”

Borremans said that the green economy has performed well despite the 2022 downturn and rising interest rates. “ESG momentum is a critical factor and something we should all be monitoring more closely supported by engagement and active ownership.”

He added that economies and regions will increasingly suffer from extreme weather impacting GDP growth, productivity, resilience and inflation and feeding into sovereign creditworthiness and corporate health.

He said that the growing climate crisis will require a more steady and active governance, especially in asset classes like high yield. High yield is approaching a “maturity wall” with billions of dollars of high yield needing refinancing going forward. Looking at corporate governance as a proxy provides a useful window into how successfully companies are managing this risks.

He also noted the importance of engagement, advising the audience that setting clear targets and incentivizing top management triggers corporate change. “Engagement is not always an easy ride, but it can pay off.”

 

CPP Investments has produced a framework and standardised template to measure the capacity of organisations to remove or abate GHG emissions. Speaking at Sustainability in Practice at the University of Oxford, Richard Manley, the Canadian fund’s chief sustainability officer, managing director and head of sustainable investing, explains how investors can encourage corporate efforts to decarbonize.

Given around one quarter of companies in CPP Investments’ public equity allocation still don’t report Scope 1 and 2 emissions — one of the most fundamental indicators of whether a corporate board is engaging on the climate emergency — there is much to do.

Manley argued that rather than focus on what must be done to reduce emissions, companies should start by looking at what they can do, and what they can do today. He suggested companies look at corners of their business where they have a technically proven ability to decarbonise and told delegates that helping corporates prioritize the highest impact and economic opportunities of decarbonization will give them confidence in their progress on the path to net zero.

Investors can support companies transition by encouraging them to put the details in their business plans, and take possible steps regardless of uncertainties around the carbon price or regulation; unknowns around moonshot technology and offsets.

“It is about the technically feasible stuff. If companies are going to provide forward looking statements they must provide the market with data to show if it is either a slam dunk, or just speculative,” he said.

Manley said  companies have an ability to decarbonize their businesses that many don’t realise. A study by CPP Investments explored transition plans at 12 portfolio companies, and found a playbook from a firm baseline for each. “It’s difficult to chart a course if you don’t know where you are today,” he said. From a firm baseline, it is possible to calculate abatement capacity by, for example, starting with efficiencies and changing the how rather than the what.

“The price on the screen does not reflect the climate risk of businesses we own,” he said, echoing comments shared by other conference delegates that climate risk is systematically undervalued.

Businesses should understand that if they don’t decarbonise, they will lose market share and see their value deteriorate, he continued. Once a company understands it has a value at risk that it can protect through decarbonization, it reframes the discussion.  He urged investors to engage with corporates and their consultants on that basis.

Investors can also add pressure for change by reminding corporates that operate in markets where governments will regulate to decarbonize the economy that executives need to act. “It sits with the responsibility of the director to ensure it gets done.”

Shorter-term goals are more rigorous and provide a more solid foundation. He added that investors can also withhold support for directors if the companies they oversee don’t begin on a journey of identifying and quantifying climate risk.

“We expect boards to provide oversight and counsel to ensure all business risk is covered,” he said. He said investors are frustrated they haven’t seen more action and linked it to poor governance.

Investors can’t control regulation, but he said CPP responds to most public consultations. On another note, he said engagement is easier than divestment. To divest, investors need to believe the company won’t respond to calls for change, and that that if they do, those responses will fail.

Manley added that investment opportunity in so-called grey assets is growing and said the pension will continue to finance the transition. He noted a shortage of potential bids on some grey assets creating an opportunity. “We have an increased conviction in the opportunity to invest in and capitalise on decarbonization.”

Manley concluded with a note on the importance of investors doing themselves what they are asking companies to do. In one initiative, CPP Investments is reducing business travel, aware that not every flight has a business rationale.