By Daniel Archibald | CFA
In 2017, a survey by the Lowy Institute indicated that 87% of Australians thought that climate change was an important threat to our way of life, a number which has grown significantly since it bottomed in 2012. In the U.S., the number is lower, but climbing, with a recent Gallup poll putting the worry of global warming by Americans at closer to 60%. The number of us that believe climate change is being spurred along by human activity has also been climbing, with a majority of Australians and Americans now believing as much. This proportion is still probably too low in the mind of the scientific community, but even without a consensus across society, changing of behaviours to curb global warming are well under way.
Most all global corporations now have business goals in regard to their carbon footprint, and the Paris Agreement on climate change has been signed by 194 nation states and the European Union. Of course, President Trump has issued notice that the U.S. will withdraw from the accord in November 2019; a hat-tip to many of his supporters who do not accept the science or the suggested mitigation strategies (or who otherwise are inclined to believe in deep-state conspiracies). Many investors, large and small, are also wondering what climate change means from a portfolio construction point of view.
Socially-responsible investing (SRI)
An investor might address the risk of global warming by trying to reduce the extent of mankind's effects on the environment. This is an activist investor approach to solving a large problem. Many fund managers will look to filter out companies that are perceived to be doing serious harm to society in an attempt to move capital away from carbon positive businesses towards those that are carbon neutral (or even negative). These same fund managers, along with other large investors, might also be able to influence corporate decision making through voting and other meetings with senior managers.
As this sort of activism grows in momentum, greener companies with sound business ideas, are likely to benefit from more liquidity and lower costs of capital. Of course, market participants will still be focussed on earnings and growth, and companies that are not able to provide adequate returns on capital will be dealt with by normal market mechanisms.
Climate risk investing
There is the lingering question on whether we as a human family are actually able to reverse the effects of all of our fossil fuel burning over the last 200 years. The greenhouse effect is well and truly underway and there is a concern that either (1) we won't do enough to stop adding to the problem, or (2) we might be able to stop adding carbon to the atmosphere, but the residual affects of the last 200 years will continue to keep temperatures inching upwards for the foreseeable future. The climate risk investor is thus, less interested about helping to solve the problem and more about protecting their portfolio from the risks climate change bring.
For the planet, climate change, especially if it is too rapid, brings a number of adverse affects from rising sea levels to a loss of biodiversity. For a portfolio, the affects are likely to be less direct and could include:
- Legislation against environmentally-unfriendly activities - this could be smaller measures such as taxes on carbon, to larger measures such as the banning of fuel-burning automobiles. This could lead to risks specific to industries or companies
- Social investor activism - Activist investors are likely to already be having an affect on costs of capital, and some companies in the future might have large 'climate' risk premiums attached to their equity and debt. At the same time, cheaper costs of capital for environmentally friendly companies may lead to higher returns
- Risk and opportunity - warmer climates are likely to benefit some companies and negatively affect others. Logistic companies might benefit from the opening of northern sea lanes, whereas ski resorts might suffer from smaller seasons.
Regardless on personal views on climate change, it would be prudent for all investors to understand how the effects of a warming planet might affect portfolios. The effects of excess carbon in the atmosphere are likely to affect societies and economies slowly and over decades (if not centuries). And so any strategy that might look to incorporate climate risks into portfolio construction should also be long-term in nature.