Greenflation – ESG Feature
The market environment around ESG incentivises everyone to be invested in
almost the same positions. Madeleine King,
Legal & General Investment Management
18% in a 3.2-degrees scenario relative to a world without cli- mate change. And that would be even higher in Asia,” he says. “So that could end up being either deflationary or inflationary depending on whether it materialises as a supply or demand shock. But we can agree that either way, the priority should be on avoiding that level of economic loss in the first place,” Nietsch adds.
Whatever the likely worse-case scenario, greenflation inevita- bly presents a challenging picture for investors. Bernhardt has some interesting advice on how investors can make the most of the situation. “You can play the commodity angle, invest in commodity producers, ideally the most sustainable ones, or more interestingly, invest in low carbon solution providers,” he says. “Increasingly more companies are developing new tech- nologies to address decarbonisation challenges. And investors are providing capital for these companies to do things to scale. Embracing sustainable investment processes is the best thing to do to address greenflation causes in the real economy and related portfolio effects.
“What we are seeing in our portfolios in the investment land- scape is that the energy transition presents a whole host of risks and opportunities, and as asset managers we can strive to avoid those risks and take advantage of those opportunities.”
A rethink
King says though concerns about greenflation could present a rethink of LGIM’s approach to ESG. “We may have to rethink if every fund needs to be 100% sustainable. I would argue, not every one of our clients wants that. Some will, and that’s fine.” On investor trends in a greenflation environment, Lucchese offers some recommendations. “When we focus on greenfla-
tion, long-term investors certainly need to pay attention to how macro-trends are translating into local market dynamics and who the leaders are going to be out of robust strategic position- ing in the short and medium term,” she says. King says a problem for investors is they are bound by ESG regulation, which, of course, could be creating greater green- flation problems. “Looking at this from the position of an investor, I would argue that the way regulation is positioned and moving right now is only going to make matters worse,” she says. “Everyone is incentivised to chase the same small number of super green companies to invest in. And the demand for more to be as green as they can be is growing.” It raises questions for pension funds as well, says Lauren Wilkinson, senior policy researcher at the Pensions Policy Institute. “While greenflation is unlikely to cause pension investment strategies to backtrack on ESG progress, rising costs and limited supply of the raw materials needed for the creation of renewable technologies are likely to further compli- cate decisions about how best to allocate investment in order to meet targets and mitigate risks,” she says.
Biggest scope
King challenges such conventional ESG investment thinking. “You do not need every company to be perfectly green and tick the taxonomy box today. But you need everyone to improve and transition across the climate path. It is here where we should be concentrating – on those with the biggest scope for change.” This leads to a more compromised and less idealistic ESG approach to avoid the problems posed by greenflation: with investors currently chasing the same green investments. “I think in the UK there is time for the green definitions to be a lot more practical than the EU taxonomy,” King says. “Hopefully in the UK we can get the regulation to be a little less restrictive,” she says. “There needs to be some compromise if we are to construct sensible portfolios for our clients. You do not just want to let anything into an ESG fund. You want to have standards. But you do not want those standards to be so high that nobody wants to launch an ESG fund.” The piling into green investments, which in turn is boosting greenflation is also having a worrying impact on returns. “From an investor point of view the returns you can expect to generate from purely green assets is typically much lower than it was in the past,” King says. A point highlighted by Lucchese. “We are in for a sobering adjustment of market returns expectations and business trans- formation,” she says. These are worrying sentiments for inves- tors.” But Lucchese adds that it is not all doom and gloom. “Darkness is defined by light, after all, and there is an upside to this: a new economics story.” On this reading, greenflation, in all its various outlooks, may well be worth it in the long run.
Issue 115 | July–August 2022 | portfolio institutional | 35
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