ESG changed my mind on…exclusions versus engagement

Invesco’s Steve Smith reflects on the evolution of research around high-emitting assets and how he’s living zero plastic

Steve Smith, fund manager, European equities and co-manager of the Invesco Sustainable Eurozone Equity Fund


Steve Smith, co-manager, Invesco Sustainable Eurozone Equity Fund

In this new summer series for ESG Clarity, members of the sustainable investment industry tell us how their thinking on this fast-moving industry has adapted over the years and what changes that has led to.

Here, Steve Smith, fund manager, European equities and co-manager of the Invesco Sustainable Eurozone Equity Fund, reflects on companies finding climate loopholes, measuring Scope 3 emissions and how he’s avoiding plastic at home.

What has ESG or sustainable investing changed your mind about over the past couple of years?

Exclusion does not work as a tool for reducing emissions.

When we were creating our new Sustainable Eurozone fund, we set out with the belief that exclusion-based sustainable investing can be credited with the birth of the sustainable investment community and thus must be having a positive impact on overall emission reduction.

However, during our research phase we ended up questioning if, in fact, the opposite was true.

As ever, investors and high-emitting companies found a loophole in how emissions are tracked; they are not measured on a like-for-like basis. Disposals of high emitting assets or divisions were being rewarded as decarbonisation strategies. Despite the truth being, emissions of a divested division do not disappear from society. They only disappear from public equities indices, where they are heavily scrutinised. Removing this public scrutiny makes it easier to increase the output and lifespan of these high-emitting assets and therefore their emissions.

The other negative side effect of exclusion is that it starves capital from the high-emitting companies, sectors and countries that are actively trying to decarbonise. They need capital to fund their decarbonisation strategies. Excluding them slows down their transition.

Active engagement from investors combined with greater taxation on emissions would be a much more successful solution. We don’t see why this is a controversial statement.

Describe one thing about ESG or sustainable investing you’ve heard recently that has stuck with you or been particularly poignant.

We noticed some large European companies, widely held by sustainable funds, to be extremely large carbon emitters. While this fits our approach of owning and engaging with the largest emitters, those with the ability and willingness to make material reductions in emissions, it seemed at odds with the funds that were advocating owning best-in-class companies, i.e. those companies with the lowest emissions today.

After observing this we modelled the forward-looking emissions for these businesses, something we do for all the large emitters we own. We found that their emissions are rising, not falling, medium term. The key question, therefore, is why are they heavily owned?

It is because the majority of their emissions are Scope 3. Many sustainable investors ignore Scope 3 emissions, which makes no sense to us given Scope 3 account for more than two-thirds of total emissions. The reasons for ignoring them are based on data quality and the notion that companies can’t control the entire value chain they’re part of.

We disagree. Businesses are responsible for their suppliers and customers. Energy companies are considered the highest emitters, and yet most of their associated emissions are combusted by us, their customers, in our homes and cars. The same can be said for autos manufacturers, they feel the regulatory pressure to offer customers ‘cleaner’ solutions, even at a loss. This same scrutiny needs to be placed on all sectors, especially the large emitters, but seemingly, it isn’t.

What changes have you made personally this year to become more sustainable?

I am attempting to live zero plastic. During lockdown, I began actively reducing my plastic consumption. Presented with the opportunity to eat all my meals at home, more time to cook (and even on occasion grow) food and the daily walk to the greengrocers becoming a luxury rather than a chore, I noticed a drastic reduction in plastic packaging. The more one reduces plastic consumption, the more one notices how much is consumed. What started as a lockdown past-time evolved into a passion, and more recently an outright lifestyle choice. I encourage everyone to really try it, it is much easier than one thinks.  

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