Morningstar - Q1 2022 - 18

Dispatches
can be very positive. The risk is that
efforts to address the climate crisis lose focus
if people use it to promote their varied
agendas.
2 Net Zero Will Focus the Discussion for
the Foreseeable Future.
The net-zero transition isn't simply about reducing
carbon. It's a business model transformation
akin to the Industrial Revolution. There will
be winners, survivors, and casualties. If you're
on a board of directors, in the C-suite, or
allocating capital as an investor, you are trying
to figure out what you need to do to be in
the winner's circle, or at the very least to avoid
being a casualty. Defining net zero is challenging,
as is finding the best path to achieving netzero
emissions. More daunting is contemplating
a new business model while the market
is evolving swiftly and unpredictably. The investor
community, a pillar of the capital markets,
must drive meaningful outcomes through their
investments.
I read a humorous article that poked fun at
the net-zero movement. It was about an Australian
man who set an ambitious target to quit
drinking-by 2050, when he turns 101. He saw
no need to stop any time soon. That won't
work for net zero. We need meaningful progress
now, or we're not going to make it.
3 Divestment and Engagement Have a Place
in the Conversation.
One of the most critical questions of our time
is how we can decarbonize investment
portfolios. Divest from high-carbon emitters,
or engage with them? Consider Dutch
pension fund ABP, which announced in October
that it would divest from fossil fuel
producers, citing " insufficient opportunity
for us as a shareholder to push for the necessary,
significant acceleration of the energy
transition at these companies. "
Critics of divestment argue that the assets
simply end up in the hands of private
equity or state-owned enterprises, neither of
which has cared much about sustainability.
The state-owned enterprises will surely
require political will to change, but private
18
Morningstar Q1 2022
equity and venture capital are increasingly
paying attention to sustainability. As
banks face more scrutiny from global regulators
about climate risk, you can expect to
see nudging from the capital markets on
the debt side, too.
Instead of simple letter writing, those who
engage with companies need to fundamentally
challenge them on their underlying business
models and call for significant change. That
requires commitment and resources. Engine No. 1,
the activist firm that elected three candidates
to the board of ExxonMobil XOM, is a very
different model of engagement. Can it be done
at scale?
What is certainly true is that net zero represents
a fundamental transition of the global
economy, and grappling with it is part of one's
fiduciary duty. Clients I speak with are increasingly
undertaking stress testing and scenario
analysis to ascertain how to position their
portfolios. According to one model, by FutureZero
in collaboration with Credit Suisse HOLT,
pricing carbon at $75 per ton of CO2
equivalent
for scope 1 and 2 emissions results in an
erosion of more than $20 trillion to enterprise
value globally. Eighty-three percent of it
comes from just five sectors: materials, utilities,
energy, industrials, and consumer staples.
I'm not arguing that this analysis can't
be challenged. I'm simply suggesting that the
decision to divest from energy can be
underpinned by an informed investment thesis
that is guided by fiduciary duty.
4 Sustainability Shifts From 'Nice to Have'
to 'Need to Have.'
As more investors in both public and private
assets insist on greater sustainability, a screaming
need for consistent, shared disclosure and
reporting standards has arisen. Imagine a world
without generally accepted accounting principles
or international financial reporting standards.
It would be chaos. Fortunately, the infrastructure
for sustainable finance is falling into place.
Recently, the IFRS Foundation announced the
formation of the International Sustainability
Standards Board, which merges two important
standards-setting entities.
Standardized terminology is important, too. Efforts
by Morningstar and others to clarify the many
terms used for sustainable investing help
guard against problems such as greenwashing.
But in 2022, as the influence of sustainability
considerations on longstanding financial
reporting, oversight, risk analysis, and regulatory
frameworks gains steam, I expect that
terms such as sustainable, responsible investing,
and ESG will begin to fall by the wayside.
Increasingly, we will simply refer to the work we
do as investment or finance-one's prefix of
choice no longer being necessary as sustainability
becomes the norm.
5 Here Come the Retail Investors.
Over the past decade, the number of ESG
exchange-traded funds has exploded more than
sixfold. That, alongside a surge of asset
flows into sustainable funds in 2021, may speak
to the interest of retail investors, who are
traditionally last to the party-and whose arrival,
to cynical investors, heralds the top of the
market. This might be true if sustainable investing
were simply a fad, but investors are adopting
ESG as part of the transition to a net-zero
world. Individuals in North America are a powerful
client base for large institutional investors.
More growth may come, in fact, as individual
investors start investing in sustainable funds
through their retirement plans.
I'd argue that retail investors have dual
expectations: They care about a secure retirement,
financial goals, and risk, but they also care
about whether air pollution is giving their children
asthma, or whether increased incidence of
wildfires means home insurers are curtailing
coverage. The final people to join this party may
be a force that catalyzes change.
Michael Jantzi founded Sustainalytics, a Morningstar
company that specializes in ESG research and ratings.
https://www.morningstar.com/stocks/xnys/xom/quote
Morningstar - Q1 2022

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