ESG beyond exclusions

Published by Pete Smith on

Estimated reading time: 3 minutes


Research has shown that, in normal times, by cutting out your weekly steak dinner you can take an extra holiday to Malaga every year and be comfortably carbon neutral*. Stories about the impact that our daily habits have on the environment have been in the news in recent years**.

However, this is unlikely to have as much of an impact on our carbon footprint as the carbon impact of our pensions. In the pensions world, 2019 was the dawn of Environmental, Social and Governance (ESG).

What is ESG exactly?

With ESG in the spotlight you would be forgiven for thinking that its definition is widely accepted. However, concepts like impact investing, socially responsible investing and sustainable investing mean the ESG waters remain murky. 

In the private sector, ESG has predominantly been about the management of financial and non-financial risks. In the public sector, the lines between ESG and climate and social impact have been much closer. How can we achieve a consistency in approach?

Let us start by considering how ESG measures differ. One, admittedly simplistic approach, is to look at the forwards or backwards looking nature of ESG measures. Backwards looking measures include applying restrictions on the assets you hold, such as excluding tobacco or fossil fuels. Restrictions may seem like a good way to knock the ESG nail on the head. Whilst they address particular ‘sins’ do they really capture what ESG is trying to achieve? Will they lead to better long-term returns?

An alternative approach to ESG exclusions

We know fossil fuels are today’s demonised sector. One of the problems with a simple exclusion policy is that we don’t know what tomorrow’s exclusion appetite will be. Are you going to be invested in plastics, alcohol or airlines when the world decides to disinvest? 

Are there better options than exclusions? Exclusions do not take account of assets you may be holding to benefit from the changing future outlook.

The Paris Agreement measures climate change in terms of a temperature differential +2 degrees. This is an approach to statistics that all trustees and committee members will find accessible. Carbone 4, the leading consulting firm specialising in carbon strategy, measure the MSCI world index as having a temperature differential of +3.4 degrees. 

Would it not lead to a better overall understanding of ESG if we measure portfolios in terms of the increase in global temperature resulting from the holdings? 

By having a temperature increase of less than the Paris Agreement +2 degrees target, the portfolio will naturally have a lower exposure to fossil fuel producing companies. It will also invest in companies that help to combat climate change in other ways. 

Measuring ESG . . . food for thought

I began by discussing what we eat. An interesting article in the Financial Times*** recently spoke of the meteoric rise of companies who produce plant based meat alternatives. In particular, the demand for yellow peas (the 'protein of choice' for the next decades) has been huge. Shares in a meat alternative producer, increased by more than 600% in the month following its IPO in May 2019. 

A temperature based method of measuring your ESG impact would see you benefit from exploiting changing trends such as this.

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