Combating climate change can be a serious business. Under the increased scrutiny of investors, many companies are trying to generate profits while being good social actors. Some investors are now even going as far as ensuring that they only invest in companies that value sustainability. In the past, investing for a profit and “making a difference” were at two opposite ends of the spectrum — but times are changing. Profits and sustainability are no longer seen as mutually exclusive, thanks to the growing popularity of ESG investments.
ESG stands for environmental, social and governance. ESG investing can be broken down into three types: general ESG, socially responsible investing (SRI) and impact investing.
The biggest difference between general ESG and SRI is that ESG tends to be inclusive and SRI exclusive. An ESG-conscious investor will invest in companies that value sustainability, or that have expressed a commitment to improve their business practices for the greater good.
SRI investing, on the other hand, focuses on exclusion and removing bad actors from an investment universe. This means excluding companies from your portfolio that engage in undesirable activities. They can include weapons manufacturers, alcohol or tobacco, and are screened out completely, based on the investor’s filtering criteria.
Impact investing is putting your principal where your principles are. Impact investors actively seek out and direct their funds towards companies that have a proven track record of making a positive social or environmental impact on the world.
How are ESGs being treated around the world?
In September 2014, the European Union made amendments to its general accounting directives. The amendment requires large, publicly listed companies to disclose in their management report relevant and material information on environmental and social matters. They were also required to report on their management and issues related to their employees, human rights, anti-corruption, bribery, and diversity. In March 2021, the E.U.’s Sustainable Finance Disclosure Regulation came in force. The regulation requires asset managers to provide disclosure how ESG factors are considered.
In the United States, companies are already required to disclose material information (not only financial) to investors, as deemed appropriate. The U.S. Securities and Exchange Commission (SEC) has issued specific guidance on a handful of sustainability issues and are continually looking to adjust their guidance to remain relevant.
Most recently in the U.S., newly minted Energy Secretary Jennifer Granholm delivered a tough-love message to fossil fuel companies in her first official speech. In this speech, she emphasized that the transition to clean energy is going to happen. The Biden administration aims to remove all carbon emissions from the economy by 2050.
The reduction of carbon emissions at a global scale is undeniably a major undertaking. The goal is to limit the global temperature increase to a two-degree Celsius threshold. This two-degree threshold is stated in the Paris Agreement. In order to make this happen, emissions would need to be cut by at least 40 per cent below 2010 levels by 2050, and to be near or below zero by 2100. Reducing carbon emissions on this scale globally is without a doubt going to be a major challenge.
How is the world going to be able to lower emissions by this much? This is where the popular term decarbonization comes into play. Decarbonization refers to the reduction or elimination of carbon dioxide from energy sources. According to the World Economic Forum, full decarbonization of our energy systems is the only solution to climate stabilization. In practice, getting to zero net emissions requires switching to clean energy sources and shifting from fossil fuels to electricity.
What are individual companies doing to help reach this goal?
It might be hard to think of Exxonmobil, the oil giant, and environmentally-friendly practices in the same sentence, but they are trying to do just that. Exxon is working to find ways to generate a profit by capturing carbon emissions. At the start of March, Exxon created a business unit to commercialize carbon capture technology, and they estimate that this could be a $2 trillion market by 2040.
Tesla, on the other hand, is easy to think of as an environmental company (without getting into a discussion of where the batteries come from, the conflict minerals used and what happens to the battery when the car is no longer in use). Its founder Elon Musk has set up a four-year contest, with a prize of $100M, to develop a carbon removal technology. The organizers of the contest estimate that the projects could remove 10 gigatons of carbon from the planet per year (one-third of what humans generate from using energy every year). A link to the contest can be found here.
How does Claret approach ESG?
At Claret, we like to play the long game. We consider environmental, social and governance issues when evaluating a business. We trust management to run their business effectively and consciously. And we expect them to go beyond the minimum required by law.
In terms of the environment, we tend to stay away from companies focused on the exploitation of land and harvesting natural resources. These commodity-based businesses are hard to evaluate, as management has no control over the selling price of their product. These companies are price takers rather than price setters.
On the social front, we firmly believe “bad actors” will eventually have a negative impact on the valuation of a business. Whether it’s child labour, pay equity, or unfair practices, the impact on stock price is important. In the age of social media, offenders quickly find themselves in the spotlight – and that’s never good for business.
On the governance side, we are interested in the structure, alignment of interests, and operations that will lead to business success. We believe the competitive forces of supply and demand, over time, will determine which companies are acting in the best long-term interest of shareholders.