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Further reading: Al Gore fund on ESG 2.0

Generation Investment Management explains how and why investors should look beyond traditional ESG criteria
October 1, 2020

Vice President Al Gore wasn’t able to trigger a massive global effort to slow climate change in the 2000s, despite his Nobel Peace Prize and an Oscar for the documentary An Inconvenient Truth. But he has certainly been vindicated again and again in recent years, and his message of catastrophic climate change is more widely accepted than it has ever been. 

Alongside his appeals to the world in the early noughties, Mr Gore was a co-founder of Generation Investment Management (GIM). This green-focused asset management firm was an early player in what is now a massive space, spanning private equity and exchange-traded funds. But as the investment style has expanded, cracks have started to show. 

Environmental, social and governance (ESG) judgments are hard to make, even for experts looking at companies for a living. Rio Tinto (RIO), for example, is often given points for selling out of coal, but is supporting a new coal power plant being built in Mongolia for its Oyu Tolgoi copper mine and recently broke the social and governance side of the equation too by blowing up a sacred site in Australia during mine expansion works. Boohoo (BOO) has been regularly spotted in ethical funds despite numerous reports of workers at suppliers being paid well below minimum wage. 

To help investors navigate the difficult world of socially responsible investing, Felix Preston and Puja Jain at GIM have put together a report to help determine if a company will “enable and drive the changes we need to see in economic, social and environmental systems” to limit climate change to survivable levels. The report lays out five broad questions: what are the systemic shifts required to make the sector truly sustainable?; will the company benefit from a sustainable transition?; does the business have a long-term orientation?; does it have levers available to catalyse a system-level change?; and is it mobilising effective coalitions for systems change? If a company fulfils the sustainable requirements under all of these criteria, the authors describe it as "system positive".

 

The levers are weak?

But fulfilling those criteria is not always black and white. Take point four, which refers to a company's ability to drive a system-level change. Often companies large enough to have an impact on their broad supply chains will fail on other metrics. 

For example, BHP (BHP) has recently been promising to look at its scope 3 emissions – those linked to its iron ore which is used to make Chinese steel. The Australian miner supplies enough of the steel ingredient to keep buyers onside when it asks for emissions cuts. So the thinking goes. Indeed, in its latest annual report, covering the 12 months to 30 June, the company said it would “support industry to develop technologies and pathways capable of 30 per cent emissions intensity reduction in integrated steel-making, with widespread adoption expected post 2030”. 

But BHP also mines the environmentally damaging coking coal, which is used in steelmaking. A questionable choice therefore for a green-focused investor?

Perhaps not. In fulfilling the criteria in point four, BHP demonstrates an “ability to drive change”, which is clearly important in assessing its green credentials, especially if an investor is keen to look beyond renewables and other industries more obviously aimed at lowering emissions. Effectively, Ms Jain and Mr Preston are advocating compromise. There are surely limits – BP (BP.), for example, will invest more in renewables, but it is still an oil and gas company – this introduces a degree of pragmatism. 

 

Edible or not

One industry that covers similar ground to the resources sector and offers an example of using the GIM methodology for investing is agriculture and food. “The transition to sustainable food production and healthy diets has important implications for land use, for the type of equipment required and for new revenue streams for farming and food,” the authors said. Given 30 per cent of global greenhouse gas emissions come from “agri-food systems” this is no small task, especially as population growth shows little sign of slowing down. 

Under the system positive methodology, a food company would have to support feeding people healthier food, cutting down its emissions and other environmental impacts. Premier Foods (PFD) offers a good example here. To start with the positives, the maker of Mr Kipling cakes and Soba instant noodles knocked its total annual net CO2 emissions down by 5 per cent in the year to 31 March, according to its most recent annual report. 

This was largely through dropping its scope 2 emissions through a switch from heavy fuel oil to natural gas at its Lifton Devon Creamery, where Ambrosia creamed rice is made.

The company also has a whole suite of 2025 goals, including making sure all of its soy products meet Round Table for Responsible Soy (RTRS) standards, which mostly means it has not been responsible for deforestation; a 55 per cent drop in carbon emissions compared with 1990 levels; and making 100 per cent of its plastic packaging recyclable and reducing water usage by 25 per cent. 

Overall, the company is making an effort. But can it be system positive, given the focus on sweet, packaged food? The GIM report addresses this exact topic. It wants food companies to be “aligned with a rapid shift to sustainable and healthy diets”.

Premier does say it will offer a “better-for-you” option in each range by 2025, but also flags government guidelines on healthy eating as a risk to the investment case. Therefore it does not get a pass. Knowing there is a difference between an investor and consumer mindset makes this call easier – we’re happy to buy the treats but not the company, under the Generation guidelines. 

 

Do as I say 

Looking at Generation’s own investments in the same space, it has backed Nature’s Fynd, which produces protein from “a microbe originally discovered in the geothermal springs of Yellowstone’s ancient volcano”. While it is unclear what the actual product is, Generation said in a March press release the meat and dairy alternative could be used in food and drinks “across, breakfast, lunch, dinner and snack occasions”. 

Generation’s Lila Preston said Nature’s Fynd had a “highly efficient solution to help address the climate crisis”, given its product’s water and energy savings over real meat and dairy products. It’s not fair to directly compare it with larger, listed, food companies, but this is true across all sectors: ticking off the fund’s system positive criteria is certainly easier for a small private company compared with most of the listed entities. 

The report concludes that investors should be going beyond existing ESG measures to make sensible, long-term choices. But in many sectors this is a complicated question: fashion retailers might be cutting water use, but they are still encouraging consumers to buy new clothes. Miners might be tearing up habitats, but the copper they produce is needed for the energy transition. Generation has provided a strong set of criteria that investors can use to weigh up what kind of impact their money will have on the world.