Cayman’s net zero trade: opportunity over obligation
There is no doubt that the Cayman Islands will have a major global leadership role in the fight against climate change. This does not depend on anything; the groundwork has already been laid.
The asset management industry controls the allocation and re-allocation of capital in the securities markets. It has the power to force change at a corporate level. The route towards net zero via the securities markets is a twin-track process: it involves top-down pressure from governments and end-investors, and bottom-up grassroots action from motivated asset managers. The first results in an obligation, the second represents the exploitation of opportunities.
Inclusion of ESG considerations in investment decisions is therefore either a toilsome obligation for an investment manager or it is an opportunity. In some respects, it does not matter. How an investment manager ends up with an ESG policy is irrelevant if it means that it is managing an investment portfolio on that basis.
It is, however, lazy to say that both have a role to play in the fight against climate change and leave it at that. If the markets are to play an important role, as indeed they must, global policy-setters need to understand the difference. Otherwise, they cannot possibly understand where change is coming from.
There are two very different sides to the asset management industry, divided by different approaches to risk. Investment managers either define risk in relative terms (e.g., their mandate is simply to beat a benchmark, even if that benchmark has depreciated year-on-year) or in absolute terms (exploiting investment opportunities while managing the downside).
In general terms, absolute return managers see ESG as an opportunity. They are able to do so because they have the tools available to fully exploit it and manage downside risk. At the same time, those under an obligation are often pedestrian, going through the motions.
Broadly speaking, short term performance targets often encourage absolute investment managers to pursue strategies that produce results in the short-term; relative performance managers don’t have the same incentive. In turn, opportunities encourage activism, which is a more militant form of engagement. Ask any board of a multinational whether they would prefer to be at the receiving end of engagement or activism. Relative performance often requires tracking and reweighting portfolios. This creates forced selling prior to the fruition of positive impact; absolute return funds are not so hamstrung. The list goes on.
This brings us to Cayman. Cayman hosts the majority of the world’s hedge funds. They all fall into the absolute return category. Cayman gives them the necessary investment and risk management tools for them to have the right kind of capital to exploit opportunities and be transformative for the greater good. That gives Cayman a central leadership role in the global drive towards net zero. Recognition by onshore governmental special envoys and policymakers of this positive contribution is vital in the drive towards net zero.