Is engagement alone enough to ensure super funds’ investment portfolios are net zero by 2050? Divestment could still have a role to play, Bill Hartnett writes
Following my recent return to Australia after almost four years in the UK, I have been hearing ongoing discussions around the relative merits of that old chestnut: Is engagement preferable to divestment to address the challenge to get to net zero real world carbon emissions by 2050?
Given the trillions of dollars in capital allocated by institutional investors that support and drive economic activities, the sector is increasingly in the global regulatory spotlight for its critical role to reduce real world emissions.
A new slant to this debate goes along the following lines. Over the last five years, some institutional investors in Australia and globally have attempted to decarbonise their investment portfolios by introducing restrictions or exclusions of high carbon emitting companies and sectors. These efforts are part of their net zero pledges to align to the goals of the Paris Agreement’s ambition of net zero carbon emissions by 2050.
This argument then correctly observes that the world has continued to record increased emissions over this period. Furthermore, the impact of the terrible war in the Ukraine has resulted in soaring price of oil and commodity stocks which has meant that many decarbonised portfolios have underperformed their peers and benchmarks over the last 12 months.
This underperformance is a particular conundrum for institutional investors in Australia due to super funds being subjected to the stringent Your Future Your Super performance test which has tended to promote increased close hugging of mainstream market benchmarks (which themselves have no ambitions or pathways to reach net zero).
Additionally, those opposed to divestment and portfolio decarbonisation argue that it robs investors of a ‘seat at the table’ to engage with boards and executives of high emitting companies about their net zero strategies. Similarly, divestment can cause the ownership of some vital high emitting assets to transfer to private markets where the new owners may have no net zero ambitions.
We need to remember that portfolio decarbonisation efforts are still really in their infancy and actual implementation of decarbonisation strategies has only been undertaken by relatively few investors. Judging outcomes over a short period, like 12 months, is far too narrow a time scale
So, the conclusion then is that portfolio decarbonisation efforts should be discarded as they do not lead to real world decarbonisation, investors lose their stewardship influence and investment performance suffers potentially creating issues with the regulator. Not an appealing prospect for investors!
However, I think we should take a short pause (and I mean very short as urgency to address climate change grows daily) to reflect on this conclusion. For context I reiterate that I am strong proponent of stewardship and engagement to drive both better risk-adjusted returns for investors as well as positive real-world impact. I have been fortunate enough to be involved in some highly influential and outcomes-focussed climate and other ESG related initiatives over the years.
Firstly, we need to remember that portfolio decarbonisation efforts are still really in their infancy and actual implementation (as opposed to policy announcements) of decarbonisation strategies has only been undertaken by relatively few investors. Judging outcomes over a short period, like 12 months, is far too narrow a time scale.
Secondly, we need to reflect on the effectiveness of employing engagement strategies alone to reach net zero goals. Indeed, in July 2023 APRA updated its Prudential Practice Guide SPG 530 Investment Governance where it places far greater regulatory expectations specifically on investors’ ESG stewardship and influencing activities. This comes as we have seen global oil majors, such as BP and Shell, back track this year on their previously strong, ‘Paris-aligned’ climate ambitions that had been the hard-won outcome of earlier investor engagement.
In Australia, we are witnessing oil and gas majors such as Woodside continuing to disappoint investors on their net zero plans.
So, in the face of increasing real world emissions in recent years, could it equally be argued that engagement alone has been as (in)effective as portfolio decarbonisation efforts? Given that rigorous net zero climate engagement must be conducted over the 1000s of companies in most superfund portfolios, how certain can we then be that engagement alone will meet the critical net zero by 2050 real world outcome?
in the face of increasing real world emissions in recent years, could it equally be argued that engagement alone has been as (in)effective as portfolio decarbonisation efforts?
The answer to the engagement versus divestment question is that both can and must work in concert to meet real world net zero by 2050 challenge. Indeed, investors are fortunate to have several tools at their disposal to implement their net zero pledges. For example, greater priority could be placed on focussing on shorter term and more practical issues such as stronger advocacy on financial systems issues such as the need for benchmarks that have net zero pathways, continued evolution of the definition of the term ‘fiduciary’ and enabling greater investment in low carbon solutions.
Both divestment and engagement can add value and we must adopt a mindset of continual improvement in all their applications. Divestment screens do not need to be blanket sector restrictions, they can be more nuanced and, critically, ‘true to label’. As long as the screens are specific and transparent they will avoid concerns outlined in ASIC Information Sheet 271 around misleading statements or ‘greenwashing’.
Engagement activities can be made more effective though further industry collaboration and referring to net zero industry transition pathways being developed in UK and Europe as well as the UK Stewardship Code 2020.
If we are to reach net zero real world carbon emissions by 2050 then logic says that investors’ portfolios will also be at or close to net zero. As such ongoing efforts to decarbonise investment portfolios is a necessary precondition to real world decarbonisation. It cannot be dismissed outright. It is the inevitable conclusion of transitioning economies and societies to a net zero world.
Bill Hartnett is the founder of Bill Hartnett ESG and SI Advisory Services and has 25 years’ executive experience in ESG, sustainable investments and climate change stewardship. Previously, Hartnett was Head of Responsible Investment at Local Government Super (now Active Super) as well as ESG Investment and Stewardship Director with abrdn in London.
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