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Week 27: There are two types of returns (and yes, it's getting hot out there!)
In this issue: ▸ From mitigation to adaptation ▸ It’s getting hot out there ▸ The net-zero dilemma for investors ▸ There are two types of returns ▸ And much more...
I hope everyone is well and ready for yet another edition of ‘ESG on a Sunday’!
Our quest for a more (or at least a bit more) sustainable future continues.
Last week was heavy, cold and numb in so many ways. We are far off track and much needs to be done much faster and in a far more systemic way.
From mitigation to adaptation
But are we fooling ourselves? The theatre of mitigation and prevention of the climate emergency has most likely had its last showing – with many empty seats and an audience who slept through the last act.
Instead, we need to attend the good old opera play called adaptation. We have, we are and we will have to adapt to some very nasty realities.
How bad will it get? Over the last few weeks, in several interactions I’ve had with people in different parts of the world, two things have been mentioned more than ever before: Politics and regulation.
We know that politics is the biggest business sector in the world, continuously striving to reinvent its own merit and survive. There are many politicians around the world who still question if they can economically afford to tackle the climate emergency.
In their view, it’s imperative that the efforts to tackle the climate emergency do not disturb the underlying mechanisms. After all, billions of people depend on a system that, despite everything, still works. Stock markets are booming, oil prices are rising and today we have more billionaires than we had 10 years ago.
We also live in one of the most peaceful times in human history. Humanity, or a large part of humanity, has progressed in securing its material base, and a significant number of people have more than they need.
The rest – and that’s a tough one – will likely struggle even more in the future.
Worldwide, nearly 700 million people now live in low-lying coastal zones vulnerable to sea-level rise and coastal storms. That number could reach a billion by 2050. Island nations like the Maldives, Seychelles, Kiribati and others could be completely wiped out by rising seas and storms. Even a rise of only a meter, almost certainly unavoidable now, will displace millions of people in Florida and along the Gulf coast, causing trillions of dollars in damages and property loss.
It’s getting hot out there
The unprecedented heat waves sweeping over the planet recently are harbingers of the heatwaves of the future.
Temperatures above 49C (120F) swept over the Middle East a few weeks ago, earlier than ever before. Death Valley hit 53.3C (128F), just shy of the hottest temperature recorded on Earth. Last week, the small town of Lytton, British Columbia, saw the highest temperatures ever recorded in Canada – and was wiped out by a brutal and fast-moving wildfire. And the World Meteorological Organization this week confirmed a new record high temperature for the Antarctic.
The US National Climate Assessment noted that the period since 1950 in the south-western US has been hotter than any comparable period in the past 600 years, and temperatures continue to rise.
If greenhouse gas emissions continue unabated, some models suggest that more than a million climate refugees may move from Central America and Mexico to the United States. In April, the UN high commissioner for refugees released a report showing that climate- and weather-related disasters already displace more than 20 million people a year, and a report from the Australian Institute for Economics and Peace suggests that more than a billion people could be displaced by climate and weather disasters by 2050.
Most of us get the picture. It’s complicated. And it will become even more complicated (meaning, most of all, that it will be very bad for the poor people and regions of the world).
This is why we have politicians. They need to help us adapt. It’s a climate emergency and we need all hands on the deck.
No EU jet fuel tax for private jets?
The European Commission has proposed exempting private jets and cargo flights from the planned EU jet fuel tax. A draft indicates that the tax would be phased in for passenger flights, including ones that carry cargo.
The draft, which the commission will on 14 July present with its proposed revisions to the bloc’s 2003 energy-taxation directive, indicates there could be an exemption from taxation for energy products and electricity used for intra-EU air navigation of cargo-only flights. It proposes allowing EU states to only tax such flights either domestically or by virtue of bilateral or multilateral agreements with other member states.
The commission is worried that taxing fuel for cargo-only flights would adversely affect EU carriers. Third-country carriers, also with a significant share of the intra-EU cargo market, have to be exempted from taxation due to aviation services agreements, the commission argues.
Private jets will enjoy an exemption through classification of “business aviation” as the use of aircraft by firms for carriage of passengers or goods as an “aid to the conduct of their business”, if generally considered not for public hire.
A further exemption is given for “pleasure” flights whereby an aircraft is used for “personal or recreational” purposes not associated with a business or professional use.
And so, sadly, we adapt to these things too... It explains why the sales of private jets skyrocketed last year.
I wonder how we can explain to 800 million people in Asia that meat consumption is not good for the climate emergency? Or how we can explain that they need to switch their cheap fossil-driven cars to electrical vehicles which they cannot afford?
The net-zero dilemma for investors
So how do ESG investors, the beacons of light in the investment industry, in this almighty sector of the world economy, the home of self-proclaimed Gods, address this? The short answer: Net-zero.
This article on the real challenges related to net-zero pledges issued, communicated and marketed, explains three different perspectives that we need to take into account.
For example, imagine in 2025 that net-zero-pathway companies make up only half the market. Does an asset owner pick from that half while recognising the material investment constraint and knowing also that the net-zero tailwind may now be a headwind. In other words, that these assets may be priced at a premium, offering reduced forward-looking returns relative to others.
So, doing the right thing may now mean struggling to do things right when trying to deliver both the highest risk-adjusted returns and alignment to net-zero.
This is hard, very hard, since ESG is not only about generating higher returns and should not be sold that way either.
And it’s not a ‘one-size-fits-all’. It depends how it is done, where and why.
Investors who believe that investing sustainably will also deliver higher returns over the long run should be prepared for an imminent change in that narrative, an academic research suggests.
Abraham Lioui, professor of finance at Edhec Business School and an expert in the strategy of investing according to good ESG principles, believes he and his co-authors have found signs that the ESG market is reaching maturity and could become a victim of its own success:
“We are going to the zone where the positive impact of the ESG buzz on prices is coming to the end of its cycle,” Lioui said. “Soon we will be at the stage where the relationship between ESG and performance will be negative as it [logically] should be.”
You can find some very interesting pieces on ESG and performance here.
There are two types of returns…
Why is it so hard to combine real ESG with financial returns? Well, the entire point with ESG is not to provide just another financial parameter to support your investment targets. Many, many newly baptised ESG believers still don’t get this. Because the emotional part of returns is very often missing out.
All investment delivers two distinct types of return. There are the more obvious and mundane financial returns, delivering us money with which to satisfy our wants and needs.
But there are also hard, very hard emotional returns, the value we get from the very act of owning something. These hard emotional returns may come from a sense of satisfaction, or enjoyment, or purpose, often from the impact of we have had on the world.
A truly rational investment process should seek to maximise the combination of both financial returns and hard emotional returns, and not merely ignore the latter.
Of course, we all have our own idea of purpose. For some, passing a beautiful object on to the next generation is purpose enough. For some, any investment that provides capital for others to put to productive use represents sufficient purpose to feel good about it. And for others, purpose comes only from a very specific cause that we feel strongly about.
Emotional returns may come from quietly knowing we’re doing good, or from the social recognition that comes along with it. Whilst gaining social stature from doing good through our investing is perhaps less purely altruistic than doing it anonymously, it’s no less valuable. Implicit in the narrow assumption that we should maximise risk–adjusted returns is that more money is always better. And if we ignore the possibility of emotional returns this may appear to be true: the more money we have, the more we’re able to satisfy our desires and aspirations.
Even if we ignore emotional returns, it is important to recognise that money is a means to an end, not the end itself. More money is valuable only because we believe it helps us get more of what we want. But what if some of what we want can already be acquired through the process of investing, rather than just from its proceeds?
For those who care about supporting social or environmental progress, money is one of the means to support the causes they believe in.
We have emotions and values – also when we invest
The financially ‘optimal’ portfolio may be right for an emotionless robot, but is seldom the best solution for a real person. Surprise, surprise for the financial industry. It turns out that humans have emotions. They are influenced by context and environment, and their best portfolio isn’t just financially efficient, it also needs to be one that feels emotionally comfortable.
A portfolio based purely on technocratic financial reasons is unlikely to offer much comfort. Abundant evidence from behavioural finance shows that uncomfortable investors make a myriad of poor decisions along the investment journey, and achieve substantially worse returns as a result. Two of the most systematic behavioural costs are “Reluctance” and the “Behaviour Gap”.
So how do we acquire the emotional comfort we need? It isn’t about risk and return estimates. As much as we’d like to believe in the numbers, real people rarely gain comfort from them.
Instead, we decide based on stories. It’s vitally important that what you invest in reflects stories that resonate with you and that you identify with. A portfolio that reflects your beliefs is what makes your investment portfolio comfortable for you, and so enables you to avoid some of the costly behavioural responses to investing.
A portfolio which expresses your values will be one you’re far more likely to invest in, reducing the costs of reluctance: you are likely to invest sooner, reducing the drag of delay; and you are likely to invest more fully, leaving less of your wealth doing nothing over time. But it will also be a portfolio you are more likely to stick with even as markets turn down, reducing the behaviour gap: knowing your portfolio is producing impact will make you less likely to sell in panic in stressed times.
You can find more on this here.
A Russian fantasy
Lastly, in other news, Russia has claimed that its forests neutralize billions of tons of greenhouse gases.
“Our country accounts for one fifth of the world’s forests. They absorb several billion tons of CO2 equivalent on an annual basis,” Putin said this week.
This claim from Russia is not new, but scientists have their doubts. No less than eight experts told the independent English-language The Moscow Times that the government’s headline figure of 2.5 billion metric tons of CO2 is at best unproven and at worst unrealistic. “It’s a fantasy,” one expert said.
That’s all for now. Have a great week!
Best regards, Sasja