Climate change – an investment play for today?

15th January 2015

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It is often said that climate and carbon themes are not financially material risk factors in the short to medium term writes Axa Investment Management’s Luisa Florez…

As an illustration, to date there have not been any signals from carbon markets to suggest that climate change is being considered an immediate risk, as evidenced by the price per tonne of carbon at €6.69.  This is one of the lowest levels since the origin of the EU Emissions Trading System on 1 January 2005.

Similarly on the political side, a robust climate deal has not yet materialised, and there are some doubts that we will see one by the end of 2015, the United Nation’s proposed date for reaching a global climate change agreement. In terms of global temperatures rising, research commission by the Intergovernmental Panel on Climate Change suggests we won’t see temperatures rise until the second half of this century, which for some, makes it a more remote risk in investment terms.

Despite these arguments, we consider climate risk a short-term opportunity for the following reasons:

1.     Reputational risks

Climate risk is becoming synonymous with reputation risk.  Undoubtedly, there are a number of factors behind the recent decline in oil prices, such as shale gas development as well as countries returning to the markets (e.g. Libya).  Nevertheless, moral issues are also playing a growing role with the divestment movement steadily gaining traction amongst investors across the globe.  With its reference to the 1980’s South African divestment movement, the fossil fuel divestment campaign will continue to push investors to review their investment policies and determine if their reputations are at increased risk.  This was illustrated in late October 2014, when hundreds of Australian banking customers turned out at bank branches across the country to close their accounts in protest over the banks’ financing of fossil fuels.  The Big Four Australian banks have lost an estimated AU$400m worth of business since the Non-Governmental Organisation 350’s campaign started in 2013.

2.     Prices

The opportunity now exists to consider the low-carbon-economy theme, thanks to economies of scale in the renewable sector.  Additionally, there are proven pathways to invest in attractive names offering green and energy efficient products through green bonds. It is now increasingly understood that in the future, costs for dealing with climate change will be significantly more expensive, than if we were to take action now. This has already been apparent in the rising costs associated with natural disasters.  Since 1990, over 4.3bn people have been affected by natural weather related disasters, with costs estimated at US$1.5 trillion.

3.     Diversification

The number of sectors offering green and energy efficient solutions has increased. So far the most intensive carbon sectors, such as building, transport and industrials are offering innovative and less expensive solutions than were available previously, with more sectors expected to bring new solutions to market. For example, the transport sector, which was almost inelastic to the oil market, has started to offer growth opportunities to traditional suppliers and other sectors via the development of electric vehicles.

Whether an investor is interested in climate change for ‘moral’ or ‘pragmatic’ reasons, asset managers will likely need to make changes to their investment approach over time to respond to this changing dynamic.  In our view, the asset management industry has an important role to play in supporting clients’ transition to a low carbon economy.  The steps involved in this transition include; identifying and explaining how capital is being deployed to slow down global warming, avoiding investment in fossil fuel industries that do not align their strategies and capex with a low carbon economy, and investing in green technologies and energy efficient solutions, e.g. increasing exposure to green bonds.

Then investors need to consider the impact of these actions on their asset allocation decisions, and take into account the impact of the Two Degree Scenario5, put forward by the United Nations Framework Convention on Climate Change.

Climate risk, as with any other environmental, social, governance or financial risk which can impact a portfolio, needs to be assessed from a risk mitigation perspective but should also be considered as an investment opportunity, with the potential to offer good financial returns.  On that basis, we believe that climate risk should not be neglected in the investment decisions that investors are making today.

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