The recently published Tomorrow’s Capital Markets report is focussed on the need to find ways to incentivise capital to be deployed in such a way that it better supports the long-term needs of society and future generations.
There is a strong link and an overlap between this discussion about how to mobilise more capital to play an active role in creating more positive economic outcomes, and the debate about the potential for stranded assets in the traditional fossil fuels sector and the consequent need for portfolio decarbonisation.
One area that the paper doesn’t stray into is the wider tension in the investment world between active and passive investment strategies. Traditionally that debate has focussed on cost and the ability of active managers to beat a benchmark. However, the one thing we know with certainty about the future is that it must be radically different from the past.
The imperatives of resource depletion, climate change and ageing societies demand a significant reshaping of industrial activity. Traditional benchmarks are backwards looking and cannot accommodate this future orientation. One of the key conclusions of Mercer’s 2015 report Investing in a time of climate change was that the expected impact of climate change on future investment returns at an industry sector level would be even greater than the impact on returns between asset classes.
Equally, low carbon indexes which screen out fossil fuel exposure do little to create additional investment in the low carbon economy. It could even be argued that such an approach creates worse outcomes, as the divestment from fossil fuel companies by ‘stewardship’ investors without at least an equivalent reinvestment in solutions, simply results in the increased ownership of fossil fuel sectors by less responsible investors. What is needed is the diversion of capital to better uses and building a new economy… this needs active choices and capital allocation.
To do this requires a focus on the impact of investment decisions, within a framework which considers risk, return and impact in a mutually reinforcing and self-sustaining combination.
During the 19th century investors targeted returns in isolation, and in the 20th century the finance industry sought to balance risk and returns. The events of the first decade of the 21st century have shown this approach to be overly short-term with adverse impacts. What is required today is for investor focus to integrate risk, returns and impact.
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