Asset owners need investment products that prioritise decarbonisation over short-term returns
Key Takeaways:
Asset owner efforts to ease systemic risks such as climate change are held back by outdated product offerings that disproportionately prioritise short-term returns.
IEEFA calls for the establishment of “systemic funds”, a bold new category of impact product that places targets such as decarbonisation ahead of short-term financial returns. Such funds have been enabled by recent legal discourse of fiduciary duty.
Universal owners can further strengthen decarbonisation strategies by collaborating with governments, pushing for the rapid adoption of carbon markets, aiming to stymy climate lobbying, leveraging relationships with banks and incorporating divestment into stewardship toolsets.
A more pragmatic and varied approach to active ownership can help overcome the limitations of relying too heavily on corporate engagement to achieve systemic risk reduction.
26 September 2024 (IEEFA) | Asset owners urgently need access to investment products that place targets such as decarbonisation ahead of short-term financial returns.
New research from the Institute for Energy Economics and Financial Analysis (IEEFA) recommends the establishment of “systemic funds” that adopt concessionary short-term financial return expectations as a trade-off for more aggressive systemic risk reduction.
If carefully constructed—to avoid free-rider and liquidity problems—as a supplement to existing active ownership, systemic funds provide a robust solution to an opportunity set currently inadequate for asset owners.
“Enabled by increasingly favourable legal discourse on the role of sustainability in fulfilling fiduciary duty, systemic funds represent a potentially significant growth market and business opportunity for active managers,” said Alasdair Docherty, author of the report and a sustainable finance and data analyst at IEEFA.
The research also finds that active owners can drive economy-wide decarbonisation through several additional measures:
- Collaborate with sovereign stakeholders. Governments and policymakers will need to provide an enabling environment. As the world’s largest carbon polluters are state-owned or -controlled, universal owners must engage with sovereigns to reduce systemic risk.
- Endorse carbon markets. Universal owners must advocate for the adoption of stronger carbon pricing mechanisms that internalise the costs of emissions and can promote rapid behavioural change.
- Stymie climate lobbying. Given the critical role of engagement with policymakers, it is important that investee companies do not undermine efforts with their own, often hypocritical climate lobbying agendas.
- Leverage relationships with banks. Universal owners are well-placed to use their position as both shareholders and clients of banks, many of which continue to facilitate fossil fuel expansion.
- Exercise divestment as a stewardship option. Asset owners must move away from seeing engagement and divestment as a binary choice. Far from being solely an exercise in idiosyncratic risk reduction, divestment has the potential to also bring systemic benefit.
“By supplementing engagement with several key actions, universal owners can more realistically hope to move the needle on economy-wide decarbonisation,” said Docherty.
Read the report: https://ieefa.org/resources/universal-ownership-call-practical-implementation
Notes to editors
- Universal owners are long-term asset owners—such as sovereign wealth funds, pension funds and insurance companies—that effectively own a representative slice of the global economy. Diversification allows them to minimise idiosyncratic risk, which is risk specific to investing in a particular asset or group of assets with shared characteristics. However, through diversification, universal owners’ returns end up largely tied to overall market movements. This means their priority is to reduce systemic risks, often by addressing the externalities caused by entities in their own portfolios. Climate change is the single largest systemic risk.
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