‘Stupid’ was how technology and trends expert Mark Stevenson described investing in fossil fuels when he spoke to advisers at a Citywire event last year.
Stevenson explained the financial risk associated with investing in a carbon bubble – the 2,860 billion tons of carbon tied up in proven fossil fuel reserves versus the mere 900 billion tons we can afford to burn to keep the rise in global temperature below 1.5°C.
In the same vein, non-governmental organisation Global Witness’ recent article Overexposed states every cent of the $4.9 trillion (£3.8 trillion) the oil and gas industry has planned to spend on exploration and extraction in the next decade is incompatible with reaching the world climate goals established at the 2016 Paris Agreement.
How does this translate to financial advice at an annual review? First, advisers need to understand the risks of fossil-fuel exposure. As Amy Clarke, co-founder of Tribe Impact Capital, admits, this is no mean feat as the science is complicated.
‘We are in uncharted territory. There is a lot of academic evidence and investment evidence of the risks, but we are at the mercy of things like the oil price.
‘We are flying high and flying blind with relation to climate change. Some leading scientists put 10-to-12 years on our efforts to tackle it. Some say we have to do it now because, best-case scenario, we have five years,’ Clarke says.
Olivia Bowen, partner at Manchester-based Castlefield, says her firm has its own investment management offering that does fund and stock analysis, but also uses ‘good quality external research’ from Carbon Tracker, a not-for-profit organisation researching the impact of climate change, to justify investment decisions.
Castlefield also uses Ethical Screening, a provider of investment tools for constructing ethical portfolios, which looks under the bonnet of investments to see if they do what they say.
Bowen says Castlefield pinned its divestment colours to the mast when it decided its UK equity fund, B.E.S.T Sustainable Income, would quit holdings in oil and gas extractives.
‘Performance has been a bit wobbly, partly from that decision. But long term, we still think it is the right thing to do, financially and ethically.’
Most fund managers will not be as explicit about where they stand on stranded assets (a term introduced by Carbon Tracker for investments suffering from not adjusting to required global warming limits). This is an extra challenge for advisers navigating the area. Some, such as JP Morgan, which topped a global list of banks funding the fossil fuel sector in the report Banking on Climate Change, outright refuse to engage.
Schroders, however, openly acknowledges this is a complex issue for which no one has all the answers. Andrew Howard, head of sustainable research at Schroders, calls climate change an ‘unavoidable risk’ the company is taking seriously.
‘Either greenhouse gas emissions and global temperatures will continue to rise, or action will be taken to address the challenge. In either case, investors will be disrupted.
‘Stranded assets are effectively those that will be most dramatically negatively affected by action to address climate change. Discussions typically focus on fossil-fuel producers. But in practice, the risks run wider.’
He says there are no shortcuts to making sense of the risk, but Schroders has developed a range of tools to help analysts, fund managers and clients ‘better understand, measure and manage those risks’.
Clarke believes the biggest risk advisers face is failing to act on this at all: ‘You should not allow the absence of clear, compelling, sometimes risk-based data to paralyse you. But if we just focus on the risk, we can wind ourselves up for hours asking: “How big is the risk?” or “When is the risk going to materialise?”’
In this case she suggests advisers park these concerns and focusing on what the client knows and cares about.
‘What do they want their money to be exposed to? And do they realise their money might be having a dirty little affair overnight with something they really do not like?’
Responsible ownership is an alternative to divestment and has its own challenges, as activist investors in Exxon Mobil will attest. But arguably advisers and clients cannot make an informed decision on the merits of divesting versus engaging before understanding the risks embedded in fossil-fuel investments.