COP27: Investors are the wrong people to address climate changeNov 20, 2022
The leaders in the creation of the low-carbon infrastructure of the future must be those who will know how to build it, not those whose principal occupation is trading shares on the secondary market. This is why I believe that China, despite its current dependence on coal, is much more likely to achieve its future carbon emission goals than the United States.
A myriad of organisations of institutional investors, representing trillions of dollars of assets, have formed to back measures to mitigate climate change, drawing much media attention. But they are the wrong people to lead the climate fight.
Many promises have been made to pursue “net zero” carbon emissions, but too few have been kept or are likely to be kept. The result is that massive meetings held to fight climate change, like COP27 in Sharm el-Sheikh, Egypt, are dismissed by climate advocates like Greta Thunberg as “Blah, blah, blah.”
The problem is that the wrong people have been chosen – or have inserted themselves – as leaders of the campaign for “net zero” carbon emissions.
The term “institutional investors” applies to professionals who manage investments of large pools of money such as pension funds, endowment funds, and mutual funds. Since the lion’s share of assets available for investment are shares of public stock traded on the secondary market, the bulk of these funds are invested in public companies. The market for these shares is “secondary” because the money that was raised to finance the companies was provided when the shares were sold in an initial public offering (IPO). After that, the shares are traded among investors, but the cash paid for them doesn’t accrue to the companies. Thus, the idea that trading of shares based on corporate ESG ratings (environment, social, and governance) is “sustainable finance” is mistaken, because that trading has no direct financial influence on the companies. Nevertheless, investment managers have embraced that nomenclature in their advertising, not least because they can charge more when they attach a “sustainable” label to their offerings (whether the label truly reflects them or not).
For decades, the stated mission of fund managers has been to “beat the market.” Accordingly, they set goals such as “to beat the market by …” two percent, or three percent, or more. But more than 80 percent of them do not beat the market at all. And which ones do beat the market in any given year is random and unpredictable. Most of their investors would do much better investing in a low-cost index fund. This is well known in the industry; yet not only does the profession survive, it’s among the highest paid in the world because of the high fees they charge. Their practice – which they get away with constantly – is to set goals for their results, but to muddy them in such a way as to obfuscate the fact that they have failed to achieve them, or to blame that failure on unforeseeable events like “our style of investing was out of favor.” Often, they invent “custom” benchmarks to compare with that are easier to beat than the market itself. Or, while they might acknowledge that their recent performance was sub-standard, they expect their future performance to achieve and exceed their goals. Then, next time, when they have failed again, they will say much the same thing.
If this sounds implausible to you, consider the fact that the endowment funds of top universities, like Harvard, University of Chicago, Cornell, Stanford and Yale, who presumably are financially sophisticated and can access Nobel Prize winners in finance, have performed much worse over the past 12 years than a low-cost index fund.
Are these the people you would want to lead in setting meaningful goals for reducing carbon emissions? Wouldn’t they set unreachable goals and then find ways to explain why those goals have not been met, or explain – again and again – that they expect they will be met in the future?
Yet an alphabet soup of acronym-laden organisations of institutional investors have been formed to press for carbon reductions. This has gotten much media attention. People are impressed by it. They assume that if such respectable, wealthy people and institutions are driving things then progress must be made.
This is disastrously mistaken. The reality is the opposite. Leadership like that is almost destined to ensure failure.
The problem of climate change is a technical one. Its solution must be a technical solution. Leadership in pursuing that solution, as it is for moon shots, or altering the course of an asteroid, should belong not to financiers – especially those in the habit of setting unreachable goals, then explaining away the failure to achieve them or setting yet more unreachable goals for the future – but to engineers and scientists. Those are the people who should be leading this effort, not institutional investors.
This is why I believe that China, despite its current dependence on coal, is much more likely to achieve its future carbon emission goals than the United States. In China, leaders are often educated in engineering or the sciences. People in those fields are admired and trusted. By contrast, the West – the United States particularly – is enthralled with wealthy financial figures such as hedge fund and private equity managers, while scientists and engineers are often denigrated and even distrusted. It may be a reflection on this fact that while China has constructed 40,000 kilometres of high speed rail, the United States, having tried to build a high speed rail line in California for more than 20 years, has been unable to complete any.
The leaders in the creation of the low-carbon infrastructure of the future must be those who will know how to build it, not those whose principal occupation is trading shares on the secondary market.