Agility Paramount to Net Zero Investing – CFA Institute
Divergence in views on universal ownership as investment professionals align on data concerns.
A flexible mindset and systems thinking is paramount for investors looking to align their investment strategies with a net zero future, industry thought leaders have determined.
New research published by the CFA Institute Research and Policy Center, which draws on insights from 20 investment industry experts, has outlined the strategic importance of net zero investing and the imperative for a mindset shift to embrace the level of transformational change and capital flows needed to align with the goals of the Paris Agreement – all without compromising returns.
It identified three critical components for successful net zero-aligned investing: the development of organisational frameworks putting net zero investing into practice; innovating to integrate net zero investing into mainstream investing; and maintaining a careful balance between net zero and risk and return goals.
For the latter, net zero investment strategies should also consider government and regulatory policies, engagement with other stakeholders, and the enhancement of organisational capabilities, the paper suggested.
An investor’s collaborative environment is also crucial to ensure faster learning and more coordinated efforts, it added, encouraging investors to attract talent from diverse fields.
“Practices around net zero investing are still unsettled and nascent,” Chris Fidler, Head of Codes and Standards at the CFA Institute, told ESG Investor. “A net zero-focused investing ecosystem requires flexibility in thinking, not dogmatic views. There’s a lot more space for exploration and to think about how climate objectives can be achieved.”
The paper outlined recommendations for investment organisations to better support the transition to net zero, including building deeper organisational beliefs about climate and developing their understanding of what net zero investing means in practice.
Systems thinking – which involves adopting a problem-solving approach that views issues as part of a broader, interconnected system – is crucial to facilitating a robust net zero investing landscape, Fidler claimed, noting that it provides new insights that more traditional academic models often don’t have the flexibility or breadth to capture.
“It can be a powerful tool to identify investment solutions,” he explained. “It’s interesting to see the investor uptake, [as the finance industry’s] history of thinking has been more reductive – make simplified assumptions and come up with tractable and mathematical models.”
Research published by the CFA Institute earlier this year indicated that responsible investment funds offered by retail and institutional investors in Europe, the UK and US almost tripled in size between 2012-22, with assets under management increasing from US$2.21 billion to US$5.97 billion.
Shared beliefs and challenges
Concern about global warming and belief in the importance of net zero was consistent among participants in the research.
They agreed there is a very high likelihood that the performance of individual issuers and capital markets will be affected by climate change outcomes, meaning every investor should consider climate impacts in their risk management wherever there is performance materiality.
In addition, interviewees emphasised the importance of incorporating climate risk management into their fiduciary duties.
“We are gradually coming to the realisation that a more holistic understanding of fiduciary duty is critical to preserving capital over the long term,” said Hiro Mizuno, Special Envoy of UN Secretary-General on Innovative Finance and Sustainable Investments.
A separate survey published by UK-based pensions and investments consultancy LCP highlighted that 25% of pension scheme trustees believe that managing systemic climate risk should form part of their role.
The survey, which will be published in full later this month, added that 44% of trustees said that they believe consideration of climate risk can already be considered part of their fiduciary duty.
The industry experts interviewed by the CFA Institute were also aligned on what they thought were some of the biggest challenges – such as the availability, comparability and credibility of climate-related data.
“I suspect that building better data across multiple aspects will be a steep task over the next couple of years, but we must do it,” said David Blood, Senior Partner at Generation Investment Management. “When I think of the challenges, data seems to be at the top of the list.”
Last month, the CFA Institute Research and Policy Center published research on the role of generative AI in leveraging unstructured and alternative data to drive an increase in investment opportunities, noting that investment professionals need to embrace a more holistic and scientific approach to investing to stay ahead.
Although Fidler claimed much progress has been made in this area, the data problem isn’t yet solved. “We need some patience, but we need to keep working to overcome these problems,” he said.
Different views
However, there were also some areas in which the thought leaders diverged in their opinions.
There was much debate around stewardship and the concept of universal ownership, Fidler revealed. Universal ownership refers to the philosophy that global investors own a slice of the market and therefore can’t diversify away from systemic risks like climate change.
“It’s more about beta and less about alpha,” Fidler said. “Under that philosophy, it makes sense that an investor would want to have systems in place that promote or enable more stable, long-term and consistent returns.”
The counter-argument divulged by some interviewees was that perhaps, by being so diversified, universal owners risk diluting their influence in the way society operates.
When the investment industry discusses sustainability in universal ownership, it tends to “generalise” that sustainability is going to be good for society and for the planet, so it must therefore be good for the portfolio, according to Tom Gosling, Executive Fellow in the Department of Finance at London Business School. He noted it is much more complicated than that.
“When you dig into it, you can get big misalignments,” he said. “Isn’t that the whole point of externalities? People often want to reframe this challenge into a time-horizon problem only. But it is not just a time-horizon problem; it is an externalities problem, and some externalities cannot be internalised even if you are a universal owner.”
There is also the issue that investor power is often overestimated to being about action that is not aligned with the long-term value motive, he suggested. “I think that the investor tools are weak and limited. If you acknowledge these two premises, it will potentially cause you to take some different actions.”
This work follows the CFA Institute’s collaboration last year with the Global Sustainable Investment Alliance and the UN-convened Principles for Responsible Investment (PRI) to better align across responsible investment terminology to ensure clarity and uniformity.
The CFA Institute will soon be publishing papers exploring how benchmarks, incentives and time horizons might need to change to support a net zero future, Fidler revealed.
“We are increasingly aware that the investment community has got a significant role to play [in achieving net zero],” said PRI CEO David Atkin “So instead of being rather passive passengers, just along for the ride, we now recognise that we need to step in and influence the environment that we are operating in.”
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