Monthly commentary

As I got positive feedback from my offer to supply summaries of interesting investment webinars that come my way, I am going to try and precis a 50 minute presentation from Morningstar (MS) from a mini-series called “Investing in times of climate change”. There is a full written report with this title that I can access if anyone wants all the details.

As context, I need to point out that the presenation was from MS European and Asian staff, for reasons that will become obvious and the work underlying the report was done by the MS subsidiary Sustainalytics, itself now a ‘bete-noire’ of the US organisations that are influenced by the fossil fuel businesses and anti-sustainablilty lobby – a surprisingly powerful group of people.

There was a lot in the presentation and even writing notes for a precis, I had over 20 points, so this is a VERY condensed version.

Main points

In the database covered by Sustainalytics to which they applied their assessment methods (more of which later) not a single business was aligned with the +1.5C climate temperature rise target that is generally linked to the 2015 Paris Agreement.

MS have defined 5 types of portfolio strategy, or labels to attach to a company: Low carbon, Climate Transitions, Green Bonds, Climate Solutions and Clean Energy/Tech. Whilst Green Bonds is obviously a discrete category, the demarcation lines and classification rules for the others were not imediately clear to me from the presentation, but likely would be after reading the report.

Growth in climate focused funds has ballooned over the last 5 years, but this is nearly all in Europe. China now has more money in climate focused funds than the USA!

2021 saw record inflows into climate focused funds and in line with markets overall, they have since declined, but less rapidly than the whole market.

China has a growing but volatile (because heavily influenced by retail investor speculation) market for climate funds partly because of the Chinese government’s, often misreported, strong commitment to zero carbon goals.

Outside of Europe, the USA and China there are only a tiny number of climate focused funds with Australia, Canada, South Korea and Taiwan currently having a handful each. However, this market is growing fast from this low base.

Investors at the moment most prefer the Climate Transitions segment of the 5 categories defined by MS.

Tests by Sustainalytics against carbon emissions deliver better results for the Low Carbon (no surprise there) and Climate Transitions groupings and worse results for Clean Energy/Tech. The latter sector has been the least popular with investors recently but I did not spot any comments about correlation with emissions assessments. More was explained about the mehodology of scoring the companies and groupings later on.

An interesting aside observation supplied was that companies producing clean energy will in many cases still have fossil fuel operations, so as businesses will score badly on emissions measures.

The keystone measure used by Sustanalytics is Implied Temperature Rise (ITR). This is made up of a 2 part measurement/assessment: actual data in the public domain or made available to MS about the firm’s climate policy and actions, and in addition a governance or management quality factor. I would imagine that the latter is likely to be controversial and potentially highly annoying to some firms!

Some stock examples where firms that on the face of it might look good for ESG investors scored very badly using this methodology. L’Oreal was one, apparently because its supplier chain, being of course mostly chemical companies, have very poor scores for emissions. I had never thought that there should be a limitation on the use of make up by eco-warriors, but it seems very appropriate!

When the whole universe of ITR rated stocks was averaged out, the result was +2.5 degrees, so way out of line with the ambitions of the Paris accord. However, understanding the way this data has been derived is not so easy.

The presenter (English) from Sustainalytics showed an example fact sheet that is available to MS subscribers to the appropriate service level (All MS webinars have a sales objective that surfaces towards the end) and explained that their users want a ready made independent assessment of companies’ ambitions on climate related objectives so Sustainalytics has created more than 80 data collection points that are weighted to give a score against a target company’s own published plans and expectations, with the results seeming to show quite wide discrepancies. An element of AI processing is used to generate the resulting graphical outputs.

Observations

I found much of the data about investors’ attitudes to cimate change and carbon emmissions reduction generally encouraging. However, I found that I was thinking along the lines that it is not safe to accept carte blanche an assessment of a company’s suitability for investment based on rather arbitrary classification into one of 5 possibly overlapping groups and an ‘AI’ influenced score based on data that may not even be reliable. I am especially sceptical of over-classification using labels, which is in truth MS’ bread and butter modus operandi. I also am skeptical of MS use of the fashionable ‘AI’ label – I guess they have been using algorithms for years and there is no such thing as an intelligent algorithm!

I think it is maybe fair criticism of Sustainalytics by some senior people in US companies and institutions to suggest that they at least appear to be taking a political stance. Of course, the majority of governments, who by definition are taking a political stance, support the Paris accord climate obectives and later ones too, so MS are not on the face of doing work that does not have public consent. What is maybe worrying is that their methodology is proprietary, to a degree a commercial secret and could, in my opinion, generate misleading and unhelpful results in at least some cases.

I personally, as a very politically sensitive person, am all in favour of investors knowing about the real (as opposed to stated for PR purposes) influence on the environment of companies in the funds they own. But I would not be happy if I found the manager was picking stocks with over reliance on computer generated score sheets or databases.

As with many aspects of making sustainable investment choices, we find ourselves being given tools that are along the lines of what we want, but are probably rather less sophisticated than we would like. I feel at times like I would if I was asked to identify a small bird in the tree tops using Lord Nelson’s telescope!

PS Since publishing this piece, I see a headline in the FT – “UK set to unveil plans to regulate ESG rating agencies”. Your scribe is on point!