Sustainable investing and generating returns go hand-in-hand

    Sustainable investing and generating returns go hand-in-hand
    © John Cain

    Sustainable investing has a problem. Accusations of greenwashing are growing louder, and too often, says Hubert Keller, Lombard Odier’s Senior Managing Partner, they are justified.

    At the University of Oxford’s World Forum on Enterprise and the Environment, he told an audience of world-leaders in policy, academia and business that the financial industry’s approach to sustainable investing needs a radical overhaul.


    Disrupting the universe

    “The sustainability transformation is likely to disrupt between 90% and 95% of our investment universe,” Hubert Keller said, in opening. “We see it as unfolding largely across three key chapters: the electrification of our energy systems, the return of 20% of agricultural land to nature, and a reduction of primary materials use by about a third by 2030.”

    Understanding systems changes is essential to generating returns for clients

    For investors and the financial industry these dramatic shifts pose two key, overlapping questions, he explained. The first – impact – seeks to deploy capital into those companies that will accelerate the transition, and avoid those that will lag behind. The second – investment returns – must anticipate the effect of systems changes on financial markets, and position portfolios to capture the upside as the economy transforms.

    Read also: Sustainable investing


    Aligning for impact

    “We have to be honest with ourselves. As an industry the framework we’ve been working with, what we call the ESG 1.0 framework, is absolutely not fit for purpose,” he acknowledged. Traditional ESG assessments give a snapshot of a company’s environmental footprint, but they are “failing to assess whether a company is active in the right or wrong activities.”

    “Under this framework most companies are deemed sustainable,” he added. “So it’s very convenient for the financial industry. We can build lots of so-called sustainable portfolios, and you can see that the industry is under severe attack over greenwashing issues, and quite rightly.”

    As an industry the framework we’ve been working with – the ESG 1.0 framework – is not fit for purpose

    Regulators are now pushing for change. Under ESG 2.0, “companies will be considered sustainable only if they are making a meaningful contribution to the transition.” And asset managers and banks that promote sustainable investment products will be forced to own a minimum number of truly sustainable companies, he explained.

    While this is good news, it brings a new problem: “Given the supply chains, and the unsustainable nature of the wider economy they operate in, very few companies will be deemed truly sustainable. So how are we expected to deploy capital at scale in such a narrow investment universe? For Lombard Odier this is a USD 300 billion problem. For the wider industry it’s a USD 130 trillion problem.”

    Even companies committed to the sustainability transition may fall on the wrong side of this new equation, Hubert Keller said. “A manufacturer of plant-based proteins may have an issue of water consumption. A battery manufacturer may face issues in its supply chain. And a company leading the way in recycling may have damaging landfill activities which it is still in the process of resolving.”

    Read also: Food Systems

    The creation of a robust, forward-looking, industry-wide sustainable investment framework will be key to putting an end to greenwashing and bringing greater transparency for investors

    The solution, he concluded, is to adopt a forward-looking assessment framework that takes into account both a company’s current activities and its future sustainability trajectory. “This will broaden our investment universe because many more companies actually do have a credible plan. This approach will deploy capital where it is most needed.”


    Investment returns amid systems change

    An effective financial sector requires industry agreement on this alignment framework. To put an end to greenwashing, a robust and transparent framework must apply to all market participants.

    Within the question of investment returns, however, there is room for disagreement, Hubert Keller said. “This is actually a far more complicated question than the alignment framework. It is a matter of judgement. It will create healthy divergence between investment firms.”

    Here, analysts must take into account both a company’s specific working practices and the wider view of “how value chains will be disrupted and how profit pools might shift.” For instance, the car industry’s roadmap to net zero involves a rapid shift to electric vehicles, but as materials extraction reduces, and as car ownership and usage change, it likely also involves a drop in overall car numbers.

    Read also: Reducing transport emissions

    “As the value chain is transformed there will be new opportunities in EV charging infrastructure, or in power generation, or in battery technology. There will also be opportunities in operating fleets of vehicles – we might produce fewer cars but we will use them more.”
    “This,” he said, “might explain the wild divergence of valuation of companies such as Tesla and Toyota. While Toyota may sell ten times more cars than Tesla does, Tesla is well-positioned to capture new profits pools emerging in EV charging infrastructure, battery storage, power distribution and data.”

    “Understanding these systems changes is essential to generating returns for clients,” he added.

    Read also: Unlocking decarbonisation – the rise of low price, clean energy

    Make or break

    The creation of a robust, forward-looking, industry-wide sustainable investment framework will be key to putting an end to greenwashing and bringing greater transparency for investors. It will also offer banks and asset managers a deeper understanding of the extent to which firms are exposed to fundamental systems changes, and so their potential as a generator of investment returns.

    The sustainability transformation is likely to disrupt between 90% and 95% of our investment universe

    As industry understanding grows, a more nuanced perspective will emerge, Hubert Keller explained. “There will be tensions – for example a poorly aligned copper company that stands to gain from electrification. And there will be grey areas, where a company is not aligned but has a great business model for the transition.” In the majority of cases, however, the direction of travel is clear – “alignment and financial returns are closely connected.” There need be no “trade-off” between sustainability and investment returns, these positive outcomes can go hand-in-hand.

    In finishing, he returned to the need for a fundamental overhaul of the current ESG metrics. Whether or not the industry is able to agree on a new, robust sustainable investment framework, and to properly articulate the nuances and tensions this forward-looking approach brings, he concluded, “will make or break sustainable investment, and potentially unlock the trillions needed to accelerate the transition.”

    Important information

    This document is issued by Bank Lombard Odier & Co Ltd or an entity of the Group (hereinafter “Lombard Odier”). It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a document. This document was not prepared by the Financial Research Department of Lombard Odier.

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