Allocating capital is the core business of investing. However, when investing through secondary markets, which is the largest part of what we do as asset managers, the link with actual new capital allocation is limited.
Why then are we often held accountable for any investments that make a negative impact, but are scrutinized for taking credit for those investments that make a positive impact?
- Proving that buying and selling stocks or bonds creates change is hard
- Decarbonization supported by engagement does make a difference
- Creating impact in secondary markets means investing in innovative companies
In the secondary market, there is always a buyer for everything we sell, and vice versa. We can influence prices, but selling or buying stocks or bonds does not lead to change in the real world directly. There are several mechanisms through which investors can influence real world change.
Allocating capital to companies based on ESG performance or impact can increase a firm's cost of capital (which becomes important when money needs to be raised), or it can signal to stakeholders that the company should change its behaviour. Unfortunately there is not a lot of empirical evidence yet that this is particularly effective.1
And then of course companies with higher costs of capital require higher returns, which could be interesting for financial-only investors. Another interesting perspective on this is given in our five-year Expected Returns, where we examine the potential climate impact on asset prices.2
Companies tend to be valued on cash flow models. Besides the long-term argument of a high cost of capital leading to higher returns for ‘brown' companies, you can also use the shorter-term argument of an adaptation period. This takes into account climate change impact and how the cashflows of companies will be affected by climate change risk in the medium term. We assume that in the coming five years a positive climate premium will be priced in, leading to lower returns for ‘brown' companies during this ‘adaptation period'.
Firing on all cylinders
As investors, the challenge for us is to reduce our real world negative impact and increase our real world positive impact. However, there is no clear evidence yet we can do this through capital allocation, though we have found other ways of exerting influence. An example of this is our net zero roadmap, which aims to help achieve a carbon neutral world by 2050. An important part of this is decarbonizing our assets.
But as discussed above, by selling our most carbon-intensive assets, the world does not suddenly emit less carbon. Therefore, we add other elements to our roadmap such as…continue reading.
1Is Exclusion Effective?, David Blitz and Laurens Swinkels, The Journal of Portfolio Management Ethical Investing 2020. And Cost of Capital and Sustainability: A Literature Review, Gianfranco Gianfrate, Dirk Schoenmaker, Saara Wasama, Erasmus Platform for Sustainable Value Creation,
The article is sponsored by Robeco.