Buckle up for a ‘disrupted and depleted planet’

Sustainability risks have an impact on all of us, requiring us to make changes spanning everything from how we travel and what we eat to the way we invest. 

Why should advisers and their clients care about climate change, biodiversity loss and social inequalities? Because they can no longer afford not to, says Aviva Investors.

Sustainability risks have an impact on all of us. It doesn’t matter where we live, what we do or who we are - we need to take them seriously. The changes we make must span all aspects of our lives, from how we travel and what we eat to the way we invest our money.

Marte Borhaug, head of research and strategy, Aviva Investors

That is one of the key messages of Aviva Investors’ webcast on key sustainability threats. The event, which was part of a broader series on the ins and outs of ESG investing, featured Mirza Baig, global head of governance and stewardship, and Marte Borhaug, Global Head of Sustainable Outcomes. Baig and Borhaug elaborated on the three main sustainability risks we are facing today: climate change, biodiversity loss and social inequalities.

But why should advisers and their clients care about any of them?

A disrupted and depleted planet means disrupted and depleted companies and, in turn, disrupted and depleted investment returns.

Baig cuts right to the chase: ‘A disrupted, and depleted planet means disrupted and depleted companies and, in turn, disrupted and depleted investment returns.’ That’s why global warming is not just a climate but also an economic crisis. As Baig points out, the worldwide temperature increase affects businesses on three separate levels.

‘You’ve got physical, transition and financing risks,’ he says. ‘Physical risks result from changes in weather patterns and have a direct impact on companies and their supply chains. They are most pronounced in the real asset space because large swathes of physical buildings and infrastructure assets may need to be written down, based on their vulnerability to extreme weather events.’

Transition risks, on the other hand, are linked to expected government and national policy changes, designed to aid the move toward a low carbon economy. That can include a nationwide shift to renewables or the imposition of minimum energy efficiency standards for buildings.

The most impacted sector in this category are fossil fuel companies as they have to deal with a double whammy of lower demand and rising production costs. ‘Economies are moving to alternative fuel sources like electric vehicles. That is already a setback for coal and gas plants,’ Baig warns. ‘On top of that, they have to deal with the effect of carbon pricing and the prospective obligations to capture and store emissions. This will have a material impact on their production break even costs.’

Financing risks have wide implications on high-emitting industries as well. Firms that don’t comply with environmental standards face funding cuts from investors and banks. Or, as Baig puts it: ‘Companies that fail to adapt will have to turn to more costly sources of funding, which will ultimately result in their businesses becoming unviable.’

The next mass extinction is well under way

But even if we did find a way to stop climate change, the damage that has already been done by the loss of biodiversity is irrevocable. Scientists warn against the sixth great extinction and predict that there will be more plastic than fish in the ocean by 2050.

Current extinction rates are 100 to 1,000 times higher than normal,

‘Current extinction rates are 100 to 1,000 times higher than normal,’ Borhaug says. ‘Currently, about one million animal and plant species could be extinct, many within decades. We can’t even begin to foresee the effects this will have on the agricultural, pharmaceutical and food sector, to name just a few.’

Yet, it’s not just climate and ecological issues investors need to be aware of: social

challenges can affect a company’s performance as well.

‘We look at social risks from many different angles,’ Borhaug explains. ‘How do companies support their employees? What’s their stance on welfare policies? How do they treat customers, local communities, and the people in their supply chain? What’s the level of corruption? We also take political freedom and the level of social unrest in the respective country into account.’

If companies ignore the wide-ranging ramifications of social inequalities, they do themselves a disservice. Turning a blind eye on labour and human rights violations pave the way for litigation and reputational risks and narrows down the universe of opportunities significantly.

We want companies to step up, support their employees, take action against racial discrimination and drive inclusion.

Aviva Investors. expects the companies it invests in to recognise and tackle these issues head-on, Borhaug says: ‘We want them to step up, support their employees, take action against racial discrimination and drive inclusion.’

Ultimately, she boils Aviva Investors’ ESG philosophy down to one sentence: ‘Don’t use up the planet for our children and grandchildren.’

Three questions with Caroline Galligan, investment director for emerging market equities

1. What’s your stance on collaborating with other investment houses to push through positive changes in companies? 

Collaboration is key. As an organisation, we’ve always worked with other asset managers to try to achieve positive change within the ESG space. We are not only one of the founding signatories of the Principles for Responsible Investment, but we’re also a founding member of the Corporate Human Rights Benchmark. Additionally, we’re involved in establishing the Task-Force on Climate Related Financial Disclosure1  and, more recently, we’ve signed the Climate Action 100+2,  an investor-led initiative to ensure that the world’s largest corporate greenhouse gas emitters take necessary action on climate change.

In that initiative, you have 545 global investors with $52tn in AUM. The combined weight of that capital lends a lot more to your voice than if you were a lone wolf. It’s always been very important to us to take a collaborative approach because the more voices you can bring, the more likely you are to be heard.

2. Is there a risk that clients agree with ESG principles on paper but shy away from integrating them in their investment strategies for fear of poor performance?

I think that’s a belief that’s now increasingly being turned on its head. ESG is something that’s going to have a very big impact on a company’s performance and its future returns. When it comes to climate change, for example, we face threats on three different levels: physical, transition and financing. If investors choose to ignore those risks, they may have to pay the price3.  Put differently, it could be said that positive ESG is more likely to enhance returns4,  rather than result in lower returns - and companies with poorer ESG practices are increasingly producing lower returns.

3. Should clients have to pay more if they want a bespoke portfolio that is tailored to your sustainability preferences?

I think an actively managed portfolio that’s constructed along specific ESG lines has the capacity to generate significant excess alpha and, as such, should be priced accordingly. There was a time when some ESG funds were just based on exclusion policies and had a lower alpha capture - but that’s no longer the case.

At Aviva Investors, we integrate ESG factors as part of our investment decision-making process across the portfolios we manage and apply our company baseline exclusions policy. We also exercise our rights as shareholders to promote responsible and sustainable practices in companies in which we invest.

This article first appeared in Citywire NMA

Important information

Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (AIGSL). Unless stated otherwise any views and opinions are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature.

Information contained herein has been obtained from sources believed to be reliable but has not been independently verified by Aviva Investors and is not guaranteed to be accurate. Past performance is not a guide to the future.

The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested.

Nothing in this material, including any references to specific securities, assets classes and financial markets is intended to or should be construed as advice or recommendations of any nature. This material is not a recommendation to sell or purchase any investment.

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