Sustainable investing should be about transitions, not purity
Sustainable investing is all the rage, but is often poorly understood and poorly executed. And the result is too often greenwashing: nice marketing, little substance.
It is much more fruitful to be thinking in terms of transitions than in terms of ESG or CSR. Such approaches are often rather static (a score), incremental (an improvement compared to last year) or moralistic (dirty = bad). The future perspective is lacking and no attention is paid to the analysis of competitive positions and value drivers that are central to the valuation by a fundamental investor. Trend analysis does offer that dynamic perspective, but does not provide the tools to analyze the relevant force fields. In contrast, transition analysis (see the x-curve below, source: Loorbach et al., 2017) is about where the system is going: what is the desirable new state (top right)? What are the emerging alternatives (bottom left)? How is the regime trying to adapt (top left)? And what activities are likely to be phased out?
Transition analysis can be applied to any industry, and the more problematic industries in terms of carbon footprints tend to have more dramatic transition pathways. Just imagine what a net zero carbon world imply for the oil & gas and airline industries.
As an investor, you can anticipate and invest in transitions. To be able to do so, it is important to realize that transitions are primarily a social challenge, which entails behavioral change, disruption and therefore also resistance; that the long term can be much nearer than expected; and that of course there are also many opportunities involved. But perhaps the most important thing for an investor to understand is the non-linear and asymmetrical nature of the effects of transitions: their consequences vary greatly not only by industry, but also within industries. Cascading effects occur throughout entire value chains, which can turn competitive positions upside down. It is therefore essential to understand second and third order effects. For example, a cost increase can ultimately prove to be good news for a company if it is even more heavily absorbed by competitors and/or is accompanied by increasing demand. It can therefore be worthwhile to invest in new data and invest time in scenario analyses (real, not in Aladdin) to map second and third order effects.
It is very useful to analyze investment through a transition lens. But take it one level higher: what do transitions mean for one’s own sector, one’s own organisation, one’s own role? During the stakeholder dialogue of a financial institution, I was allowed to ask that question to the public. This resulted in great discussions about the changing nature of added value for the customer; other required capacities of employees; and possible new products. Dare to ask these questions and enter into this discussion.
