Published 1 December 2021 by Audra Walton
‘This is the biggest capital reallocation since the Industrial Revolution,’ said Nicholas Stern to the Financial Times recently. Stern, an influential academic on the economics of climate change, is not alone in his thinking.
Few would argue. We see this shift of capital already happening. Investors are divesting, pledging new strategies of investment and reallocating capital to less risky, more forward-thinking ESG options. For example, more than 1,480 institutions have publicly committed to at least some form of fossil fuel divestment, representing an enormous $39.2 tn of assets under management. The People’s Pension is divesting £226 mn ($304 mn) from companies that fail to meet ESG standards. And a recent PwC survey revealed that half of investors are prepared to divest if companies fail to address ESG.
The creators of the European Commission’s action plan on sustainable finance can certainly take some credit for initiating this transition. Simply by requiring the calculation and disclosure of risk, as is required by the Sustainable Finance Disclosure Regulation (SFDR), investors are being made aware of the financial impact ESG issues can have on their share prices and returns.
Some companies – those that are leaders in ESG, in a green sector or part of the green revolution – will likely have no shortage of investment. But what about the companies that are not in such a position? How much risk do they face? Will they see major shareholders divesting and share prices falling?
How to determine the level of investor risk
Part of the job of the investor relations team in this new era of ESG is understanding the risk of shareholders divesting. Ninety-one percent of European investors have a company-wide policy on responsible investing or ESG issues. And recent changes to these policies, spurred on by the SFDR’s requirement for light/dark green classifications and principle adverse impact disclosures, could impact decisions on their current investments. It is not just ESG funds that are currently evaluating ESG criteria.
Even if you are speaking to fund managers annually and feel confident you understand their plans, their strategy may change in this quickly evolving environment, particularly as the pledges institutional investors are making trickle down. Moreover, you need data – data you can give to the board and C-suite that indicates the level of risk in hard, cold numbers, not a conversation.
A risk analysis is the most comprehensive approach, which you can do yourself or outsource. To analyze the risk, you will need to look at what your investors, on a fund-by-fund basis, are actually doing – not saying – as that is the only true indicator of their future behavior.
The metrics used to analyze such behavior could include things like carbon risk across their portfolio compared with yours, controversy levels across their portfolio compared with yours, governance scores across their portfolio compared with yours, and the pledges they have made as a signatory to a global agreement such as the Net Zero Asset Managers Initiative or Climate 100+ that may be at odds, or in alignment, with your own commitments. Additional financial metrics that compare your performance against the fund’s portfolio would help provide an even more complete picture as to who is potentially likely to divest.
By doing this on a fund-by-fund basis across your entire shareholder base, you will then be able to group together funds by level of risk, and relay to management what percentage of shares in issue (or free float) could potentially sell in the near term due to a discrepancy on ESG and/or performance.
How to find best-fit investment
Being proactive in finding investors that align with your company across a wide variety of metrics, including ESG (what we call best fit), would not only help to protect against the risk of current investors selling, but also help create demand for your stock and fuel fair market valuation.
This can be done by taking a set of metrics similar to those used to calculate the risk across your shareholder base and flipping them around to evaluate those funds that are not yet invested in you but could be. To create the initial list of those that are not invested in you but could be, a good starting point is to find those that are invested in your peers, sector, region or market cap. Crucially, you will then need to remove the funds that are already invested and those that you are ineligible for due to location, size, and so on. Having an accurate fund-level shareholder identification report is required at this stage, otherwise you may end up targeting current investors as if they were not invested.
After this process is complete, you can apply your ESG metrics to determine which are your best-fit investors. Comparing yourself with the funds across each of these data points will give a very clear indication of which funds you are aligned with and which you aren’t. Balancing these metrics is critical, however, as you may match on some, but not others. As such, a qualitative assessment across the entire spectrum of comparison points is an important last step in determining your final best-fit target list.
It probably goes without saying that there is no perfect process for identifying potential investors. But with an accurate shareholder identification report, good ESG data and an experienced eye, you will be able to create a best-fit target list. In an era deemed the ‘biggest capital reallocation since the Industrial Revolution’, that might be a good list to have.
Written by Audra Walton