You can’t avoid some stocks if you want to save the world

Parts of London and Edinburgh were brought to a standstill this week by the Extinction Rebellion protests. This movement has become a rallying cry for accelerated action on man-made climate change. The accusation is that progress is simply too slow.

Whilst the news crews inevitably have focused on the imagery provided by the protests, key names in UK financial services have also recently voiced calls for urgent action. Mark Carney, governor of the Bank of England, and François Villeroy de Galhau, his counterpart at the Banque de France, penned an open letter outlining steps that the financial sector would take to help the wider economy to transition to a low-carbon economy. For all the negative publicity that has stalked the big banks and insurers over the past decade, they remain the grease needed to smooth any technological transition.

While cynics may argue that Messrs Carney and de Galhau have one eye on their next job interview, the potential impact of climate change on insurance premiums, property and agricultural produce warrants heightened attention. Any destruction of value will quickly translate into the nation’s pension pots and company balance sheets. Value destruction sits as a corollary to habitat destruction.

And these warnings have not been confined to regulators. Two of the biggest financial groups operating in Britain also chose this week to warn of the impact of climate change. Blackrock and Legal & General, fund managers with more than £5.5 trillion of assets under management, both believe that climate change is something that investors cannot afford to ignore. Both warn of a looming “climate catastrophe”. The proposals put forward by both should mean greater prioritisation of climatic impact by the companies in which they invest. It is a brave business that risks locking out investment from such heavyweights.

So is this a rare “free lunch” for investors given the task with maximising our savings and pensions? Is there no trade-off between high returns and doing the socially conscious thing? Not so fast. There are three reasons why the clamour for immediate action also needs be tempered by more practical — if less headline-grabbing — considerations.

First, no financial policy from regulators or asset managers operates in a vacuum. If a significant number of institutions sell their clients’ holdings in carbon-producing companies, many of which offer high returns, they risk damaging performance. For example, with BP and Shell shares offering a healthy 5.5 per cent dividend, it takes a brave decision to omit these companies from any fund. It is all very well badging yourself as an impact investor, but, if you have no money to invest because clients have moved their money elsewhere, the result is long on virtue, rather short on impact.

There is a historical parallel here: tobacco companies. As early as the 1950s the large, negative public health impact of tobacco had become clear. However, had your pension fund refused to hold tobacco assets throughout the 1990s and 2000s, they would have missed out on a fivefold outperformance to the wider stock market. To put this into context, £10,000 invested in 1990 for a pensioner who retired in 2010 would have grown to £220,000. By contrast, simply investing in a market tracker without tobacco would have seen the same fund grow to £43,500. It took a brave fund manager to sit on the sidelines as big tobacco firms delivered big performance. Some of the best-known names in fund management today rode this wave of performance. Most of those who didn’t are now managing things other than money.

Second, it is the existing energy companies, which built their value on the back of fossil fuels, that have the resources and expertise to invest in energy research, development and infrastructure. These are the building blocks to take concept to commonplace in energy technology. While start-ups have the ability to change thinking, invariably it is incumbents that boast the scale to change people’s behaviour. By pulling back finance from the very companies with the financial muscle to build networks to support a low-carbon economy, one risks slowing the speed of technological change. This apparent paradox also holds for governments of the most polluting countries. China is the world’s biggest carbon dioxide producer and also the world’s largest producer of renewable energy capacity.

While it is an easy counter to argue that governments, rather than big energy, should be the catalysts for the green economy, most developed world governments simply do not have the funds to build these networks when this means less for schools, hospitals and public services. While these governments work out how to appease a disgruntled electorate, it will fall to private sector groups to build the infrastructure necessary for a low-carbon economy.

Finally, energy is a large part of low-income household budgets, with Ofgem, the energy regulator, finding that the poorest 10 per cent of households spend 8.4 per cent of their income on energy. The equivalent figure amongst the richest 10 per cent of households is only 2.6 per cent. Putting added pressure on carbon-intensive companies to cut energy capacity faster than cost-effective green alternatives can replace them risks being regressive as household energy prices inevitably rise. A large part of the transition to a low-carbon economy requires changing consumer behaviour — simply raising the cost of carbon production above the rate of inflation risks overly affecting those with the narrowest shoulders.

All three of these considerations are not excuses for financial services companies or regulators to move any slower on addressing climate change. Rather, they are factors that need careful consideration to avoid undermining the best of intentions. The present cacophony of protest cannot be the basis for knee-jerk, headline-grabbing reactions. The science is clear that we do not have the time to make mistakes.

A version of this piece appeared in The Times.

Simon French

Economics & Strategy