Stockholm (NordSIP) – As physical investor gatherings still feel like a rare luxury, NordSIP jumped at the opportunity to attend Man Group’s annual breakfast conference in Stockholm, which was luckily held as planned between two waves or restrictions. We thus had the chance to listen to a programme of highly engaging speakers and interact with peers from the Swedish investment community. The event proved to be particularly pertinent from a sustainability point of view, with two out of three key presentations on the topic of climate change.
Location, location, location…
First out is climate scientist Matt Goldklang from Man Numeric, who takes the audience on a hypothetical and entertaining home-buying journey to illustrate the way he and his colleagues go about modelling climate change at the asset level. In a pedagogical yet far from condescending manner, Goldklang explains why a linear model is not quite adequate when choosing our dream location as it fails to capture the complex ways climate patterns might evolve.
Running these behemoth climate models, designed to create a computer-game-like ‘twin Earth’, is not a simple task, the scientist admits. “We would end up with more than 18,000 pages of code if they were to be printed into a book,” he assures us. Yet, this complexity is precisely what the thousand-plus scientists involved in putting together the IPCC report every seven or eight years are up against. However, once their work is done, the results are still not specific enough to help solve our home-buying dilemma.
That is where Goldklang and his colleagues take over. With the help of proprietary computation systems, they downscale the results, increasing the resolution so that it is possible to zoom in onto the exact location they want to analyse. As a further step, they need to borrow AI techniques to resolve some of the issues and get a less fuzzy picture of the future predicted by the model.
Apart from an exciting exercise when planning the location of your future home, of course, the model can be used to understand the way climate changes affect an investor’s portfolio. It helps estimate a company’s revenue risk due to climate change, the potential increase in energy costs or the effect of possible flood damages, for instance.
While many scientists and practitioners are complaining about insufficient data to feed their models, Goldklang considers data availability less of a problem. “What we need more of is econometric creativity,” he says. “Based on the model predictions, how can we reimagine the future, envisioning a better world?” Goldklang urges, ending his presentation on a positive note and inviting us to think of the opportunities ahead.
How to be ‘good’
It is an ambitious task that Otto Van Hemert, Director of Core Strategies at Man AHL, takes on when he climbs to the stage at the Grand Hotel. He wants to help clients, especially those holding portfolios with multiple asset classes, invest in ‘good’ securities, good for the environment, that is. He is, however, quick to admit that constructing climate-positive portfolios is still a mixture of art and science. “It is a complex, nuanced and dynamic exercise,” he assures us. That said, at Man Group, the ambition is to be as precise as possible when defining what a ‘good’ security is and explaining how it is right to invest in it.
The emission of greenhouse gasses (GHG) is undeniably the biggest environmental threat, with energy being the main culprit, reminds Van Hemert. It means, only securities that help with the transition to a low-carbon economy can be considered ‘good’ from an environmental point of view.
Mind your scope
Van Hemert starts his quest for ‘good’ securities from a relatively easy point. So far, most investors have been focusing on corporates, mainly public equities, where data is readily available. Companies are required to disclose a lot of information, and there is an array of data providers eager to cater to the needs of investors. Yet caution is advised as ESG data is often of poor quality, and data vendors aggregate it in different ways, which sometimes leads to conflicting ratings. Van Hemert exemplifies his point by comparing how differently Tesla’s and Ford’s shares score in the ratings of two well-known data providers.
So, what explains such huge discrepancies? “When measuring the carbon footprint of a company, estimating scope 3 emissions makes all the difference,” explains van Hemert. “Unfortunately, most investors still stop at estimating scope 1 and 2, which makes it a slightly silly exercise. Ignoring scope 3 is a major issue, and it is misleading investors,” he adds.
Why bother?
Before leaving the world of corporate securities, van Hemert addresses, as promised, the ‘why’ question. Why should an investor buy ‘good’ securities and sell ‘bad’ ones? Advocates of the cost-of-capital argument, like Tariq Fancy, claim that the only way to affect change is by not investing in the environmental culprits, thus starving them for the money they need to survive. Yet, proponents of the opposing view argue, corporates will only feel pain and be compelled to move if most of the capital owners are environmentally conscientious, which isn’t realistic in the short to medium term. Isn’t it better to invest in the lagging companies and vote to change them or engage and help them transition?
Van Hemert puts forward a third point of view. “Companies care about their public reputation,” he says, arguing for the possibility to affect change by promoting the behaviour of a ‘good’ company, thus increasing pressure on the laggards to move. Increasingly, corporations are seen budging under the weight of various stakeholders, from protesters, customers, or employees.
The state of states
Moving on to the less explored area of government bonds, Van Hemert delights the audience by revealing that Sweden is the country that scores the highest on environmental factors like combating climate change and protecting biodiversity and land. Of course, developed markets, in general, tend to come up high on these metrics, as they have left the carbon-intensive industrial revolution behind them long ago. To be fair, in their assessment of emerging markets, investors need to consider a country’s current state of development, reminds van Hemert.
What to eat and how to move around
Approaching the environmentally controversial asset class of commodities from a slightly more palatable angle, Van Hemert considers the question of how we should eat more climate-smart. “In the interest of full disclosure, I have to declare that I am not a vegetarian myself, so I stand here conflicted,” he says while providing plenty of evidence that meat production is the most polluting part of the food industry. He quickly moves on to transportation, explaining why investors need to look under the hood of electric cars, too, before judging them to be environmentally safe. “Producing an electric car and its battery is typically more harmful than manufacturing a combustion-engine one,” he points out. “However, the subsequent use of electric cars is obviously more environmentally friendly,” he adds. Depending on which country you charge it in, of course.
“So, how can an investor go beyond the story-telling and decide which commodity is ‘good’ and which isn’t?” asks Van Hemert. The answer he provides is courtesy of Société Général and consultancy group RFU. They have created an innovative and comprehensive ESG rating framework for all commodities which takes into account both the production and the utilisation of a commodity. “Silver is better than gold,” says van Hemert, half-jokingly. “At least according to this framework.”
Rounding up, Van Hemert admits that ‘Good’ securities might be difficult to define or to find as they tend to come in many different shades. “You should do the best you can, though,” he urges. “Make use of data, even if it is not perfect. Communicate clearly what you are doing and why. And manage the risk in your portfolios,” he concludes.
Tricky questions
The presentation lends itself well to a couple of follow up questions on the sustainability of derivatives and short selling. With the increased availability of ESG futures, how are portfolio managers taking advantage of this recent development? According to Van Hermert, as the liquidity of the ESG-tilted futures is still not good enough, they use broad index futures. “We are comfortable with this, as we only take short positions in futures, so we don’t run the risk of going long ‘bad’ companies,” he adds.
This leads to the question of shorting in general. How sustainable is it really to short a security? To answer this complex question, van Hemert returns to the three different channels to affect change described earlier. Shorting, according to him, is sustainable if you subscribe to the ‘cost-of-capital’ argument or if you want to push for change by shifting the public’s perception of a security. However, if you are a believer in the engagement strategy, shorting might not be a good option.
These answers rounded off an intense morning of insights into the capacity that Man Group seems to have deployed throughout its organisation to make ESG an integral part of the investment process across strategies, with a particular focus on climate change. We look forward to finding out how far the managers will take it in 2022.
