ESG thinking: assessing risks and opportunities in the transition to a more sustainable economy

This article was first published in InvestmentNews.

The importance of overcoming political hurdles to addressing global challenges and ensuring better outcomes for society could barely have been better highlighted this week.

In its latest report, climate scientists at the Intergovernmental Panel on Climate Change (IPCC) warned of “a rapidly closing window of opportunity to secure a liveable and sustainable future” as they cautioned that temperature rises are “more likely than not” to reach 1.5°C “in the near term”.¹

The IPCC report was published on the same day, 20 March, that President Joe Biden issued his first presidential veto blocking legislation that would have precluded US pension funds from considering environmental, social and governance (ESG) factors, including the impacts of climate change.

Congressional efforts to block the Department of Labor’s rule allowing ESG factors in investment decision-making – removing Trump-era restrictions – come despite repeated demonstrations of how important they can be helping investors to identify opportunities and manage risks effectively.

We firmly believe that retirement plan investors in the US should be given the freedom to use a wide range of investment options to help them meet their goals. Investment choices and decisions should be left to qualified financial professionals and fiduciaries. They should not be determined or limited by politicians.

ESG thinking as a tool

At Impax, we see ESG analysis as another tool to help investment managers to do a better job of evaluating the opportunities and risks arising from global sustainability challenges. By taking a broader spectrum of issues into account, those who apply ESG thinking to their work inherently have greater potential to outperform peers who do not.

Additionally, ESG thinking can help investment managers and their clients navigate any necessary investment limitations, for example healthcare foundations may require their investment managers to avoid investing in the tobacco sector.

ESG and the sustainable transition

A striking example of ESG thinking is recognising that the world economy is in transition as global sustainability challenges, including climate change, pollution, natural resource depletion and changing social norms, reshape capital markets.

Society’s response to these challenges, shaped by disruptive forces in technology, policy and consumer preferences, are creating business opportunities on the scale of the industrial revolution across all sectors of the global economy, including in transportation, energy, healthcare, finance and agriculture.

Some of the risks accompanying this transition are not being accurately priced or efficiently managed by financial markets. For example, last year, the megadrought in the US West, unprecedented flooding in Australia and record heatwaves in Europe resulted in vast economic losses that have raised the spectre of further withdrawal of privately provided property insurance from certain regions.

Meanwhile there is growing understanding of the long-term risk posed by destruction of natural habitats; it is estimated that US$44 trillion in economic value generation – more than half of global GDP – depends significantly on nature.²

Clearly, fiduciaries acting on behalf of investors need to understand these opportunities and risks, whether they label them ‘ESG’ or not. For politicians to prohibit investment managers from analysing ESG factors – for example, deliberately ignoring flood risk in a maritime state – strikes us as particularly short-sighted.

Don’t restrict investment freedoms

The case is compelling that ESG analysis can facilitate broader and longer-term perspectives, better enabling financial professionals to deliver on their fiduciary duty to provide competitive, risk-adjusted investment returns.

Moreover, investors who consider ESG issues should be better placed to engage with companies on their risk management, encouraging the consideration of issues that may otherwise be ignored.

Any attempt to limit investment opportunities by politicising investor choice is not a market-based approach and in our view would lead to lower financial returns over time. Restrictions on ESG analysis amount to a limit on investment freedoms – and an assault on common sense.

With the scale of challenges facing global society and businesses alike, investors need all the tools at their disposal to balance opportunities and risks in pursuit of their financial goals. The Biden Administration made the right call in protecting the interests of retirement plan investors.

¹ Intergovernmental Panel on Climate Change (IPCC), 2023: AR6 Synthesis Report: Climate Change 2023

² World Economic Forum, 2020: The Future of Nature and Business

Nothing presented herein is intended to constitute investment advice and no investment decision should be made solely based on this information.  Nothing presented should be construed as a recommendation to purchase or sell a particular type of security or follow any investment technique or strategy.  Information presented herein reflects Impax Asset Management’s views at a particular time.  Such views are subject to change at any point and Impax Asset Management shall not be obligated to provide any notice.  Any forward-looking statements or forecasts are based on assumptions and actual results are expected to vary.  While Impax Asset Management has used reasonable efforts to obtain information from reliable sources, we make no representations or warranties as to the accuracy, reliability or completeness of third-party information presented herein.  No guarantee of investment performance is being provided and no inference to the contrary should be made.