Green investors need to get their hands dirty


A worker plants seedlings for reforestation at the Huayquecha Biological Station near Paucartambo, Cusco December 5, 2014. REUTERS/Enrique Castro-Mendivil

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LONDON, June 22 (Reuters Breakingviews) – The energy transition is potentially big business. To have a good chance of limiting global warming to 1.5 degrees Celsius above pre-industrial levels, the world needs to spend $5 trillion a year on new energy sources and infrastructure by 2030, according to the International Energy Agency. The capital to do so, however, is misdirected. To make a difference, investors will have to pitch in.

There is no shortage of fund managers eager to make a difference. Signatories to the UN Principles for Responsible Investment, which attempt to integrate environmental, social and governance (ESG) factors into investment decisions, have grown to 4,375 institutions that collectively manage $121 trillion . A third of them, including influential investors like Harvard University’s $42 billion endowment fund, have publicly pledged to remove fossil fuels from their portfolios. This approach, known as divestment, may not be the best strategy.

There is a seductive logic to washing your hands of polluting companies. If everyone sells the dirtiest assets, their owners will be starved of capital. Even massive oil groups like Exxon Mobil (XOM.N) could then be forced to change their ways. This idea has become ubiquitous among investors using ESG criteria. Metrics like Morningstar’s “global” ratings reward funds that have fewer “brown” assets. Investors are helping climate activists pressure companies to quit their dirtiest business.

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However, this approach can be bad for business and bad for climate change. Take mining giant Anglo American (AAL.L), which last year spun off its thermal coal assets to a company called Thungela Resources (TGAJ.J). Last year, Thungela’s market cap soared 10-fold to nearly $2 billion, as the energy security crisis triggered by Russia’s invasion of Ukraine prompted governments to reassess coal energy. The new management of the company wants to increase production.

BHP (BHP.AX) boss Mike Henry seems to have noticed. The $150bn mining giant last week reversed course on a plan to sell off its thermal coal assets, saying it would keep them until 2030. Green activists will complain that BHP is pocketing the proceeds from the sale of coal, which will represent a tenth of BHP. free cash flow in 2023, according to Jefferies analysts. However, the miner’s plan to phase out coal by 2030 is in line with the path to net zero outlined by the 2016 Paris Agreement. A buyer of the asset might have been willing to extend its lifetime.

BHP’s approach has intellectual support. ESG academic Alex Edmans admits that divestment makes it harder to fund polluting assets in primary markets. But he counters that an investor who forces a sell is also forgoing the upside in the stock price that can be unlocked by persuading a company to change direction.

An example is Orsted (ORSTED.CO). The $40 billion Danish wind farm operator is a favorite of asset managers keen to swap their fossil fuel investments for more sustainable energy providers. But the really smart investors were those who owned DONG Energy, Orsted’s fossil-fuel-burning predecessor, when it transitioned from oil and gas to renewables. Anyone who invested in DONG when it went public in 2016, before it changed its name and sold its fossil fuel business, would have made a total return of 200%. By contrast, investors who bought Orsted shares in early 2021, when trading at more than 40 times earnings, lost money.

Foregoing divestment has potential downsides. Unscrupulous investors could pocket cash flow from fossil fuels without doing anything substantial to change polluting business models. However, shareholders are increasingly demanding that companies align their assets with a decarbonization plan. The quality of emissions disclosure is also improving, making it harder for investors to do nothing.

This shift in mindset has given rise to a new generation of so-called “transition” funds that focus on challenging decarbonization goals. Take Brookfield’s $15 billion Global Transition Fund (BAMa.TO), led by former Bank of England governor Mark Carney, which wrapped up fundraising on Wednesday. The Canadian asset management giant will invest around a third of the vehicle’s capital in bets on renewable energy and another third in technologies allowing polluters to decarbonise, for example by capturing and storing carbon dioxide. It will deploy the rest by financing projects to reduce carbon emissions, for example by helping real estate groups to make their buildings more energy efficient.

The risk is that funds like these are shamed for owning polluting assets. But a transition fund is only worth the name if its investments have meaningful short-term decarbonization goals. Brookfield, for example, will require each of its investments to reduce carbon emissions at the same rate as the 2016 Paris Agreement assumes for their respective sectors, and submit to independent monitoring. Similar efforts like Aviva’s £1.6bn Transition Fund (AV.L), Generation Investment Management’s Just Climate Fund and BlackRock’s (BLK.N) recently announced strategy for transition investing should be subject to similar scrutiny.

It remains to be seen whether bridging funds can generate good returns by helping dirty companies become cleaner. But the scale of the opportunity means companies like Brookfield have a first-mover advantage. Over time, ESG investors who brag about their pristine portfolios can seem outdated compared to those who are ready to get their hands dirty.

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The Brookfield Global Transition Fund (BGTF) said on June 22 that it had increased its assets under management to $15 billion, more than double an initial target of $7 billion, making it the largest private fund in the world focused on the global transition to a net-zero carbon economy.

Brookfield said 100 investors, including public and private pension plans, sovereign wealth funds, insurance companies, endowments and foundations, financial institutions and family offices, have committed capital. He previously revealed that the Ontario Teachers’ Pension Board, Temasek, PSP Investments and Ontario Investment Management Corporation were the initial investors in the fund. Brookfield is the biggest investor in BGTF, which is co-led by former Bank of England governor Mark Carney and Connor Teskey.

Brookfield said BGTF would focus on investments to accelerate the global transition to a net zero economy while delivering strong risk-adjusted returns for investors. It will invest in the transformation of carbon-intensive industries, as well as in the development and accessibility of clean energy sources. Approximately $2.5 billion has been deployed from the fund to date.

BlackRock said on June 16 that it would establish an infrastructure strategy to partner long-term with leading infrastructure companies to help drive the global energy transition. More than half of the strategy will be allocated to Europe initially, becoming increasingly global over the coming decades.

The program will start with “single-digit billions”, the Financial Times reported on June 16.

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Editing by Peter Thal Larsen and Oliver Taslic

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