The challenge (and opportunity) of investing in a changing climate

Written by Eva Cairns on 9th Dec 2019

This article is an extract from the latest Good Investment Review, published every six months on Good With Money. Your essential guide to putting your money somewhere it matters

Our climate is changing. In recent years, we have seen an increase in costly extreme weather events such as storms, wildfires and floods. These have coincided with the hottest years on record. The need for action is clear. As asset managers, we have a vital role to help address these problem. This presents challenges – but also a wealth of opportunities for investors.


…the transition also brings opportunities

A huge task ahead

A growing population is causing rising demand for energy and food. At present, that means burning more fossil fuels. This comes with an increase in greenhouse gas emissions (GHG), a major cause of rising temperatures. GHG emissions hit a record high in 2018. As they continue to rise in many regions, the fallout could intensify.

In an attempt to tackle the crisis, 180 nations signed the Paris Agreement in 2016. This accord pledges to limit temperature rise “well below” 2°C of pre-industrial levels, and ideally within 1.5°C.

To achieve this, however, global emissions must decline by 45% in 2030, and reach zero by 2050. With current policies, we are on track for over 3°C warming by 2100, according to a special report by the IPCC.

The consequences for failing to meet this goal were laid bare by the Intergovernmental Panel on Climate Change. In its Special Report on Global Warming of 1.5°C, it detailed the environmental, social and economic damage we can expect if we don’t take more ambitious action. It made for sobering reading.

Natural disasters in 2017 caused overall losses of US$340 billion, a Munich Re study published in July this year found. This was the second-highest annual loss ever and almost double the previous year’s level. If this continues, businesses will experience more frequent and severe physical impacts across the whole supply chain. This will include damage to infrastructure and disrupted operations, water stress, poor harvests and more expensive assets and commodities.


Challenges and opportunities

To address the issue, the world needs to transition to a low-carbon economy in a meaningful way. Nations will have to dramatically reduce the level of fossil fuel in the energy mix. Many have already started to do so. In China, for example, 20% of energy is due to come from non-fossil fuel sources by 2030, according to the Grantham Institute of Climate Change and the Environment. Similar polices are in place in the EU and UK.

However, the transition presents challenges. Companies and economies will face major costs during this time. Transition risks are becoming more material as countries step-up actions to reach Paris agreement goals. Risks include those around policy such as rising carbon prices; stranded asset risk, where carbon-intensive fossil fuels become obsolete; and reputational risk – businesses that fail to demonstrate action will incur public and shareholder censure.

But the transition also brings opportunities. Considerable sums of private capital are needed to cover the shortfall in investment required for the shift towards a low-carbon economy. The International Energy Agency (IEA) estimates that achieving a Paris-compliant energy transition requires around US$3 trillion in investment every year, according to the International Energy Agency World Energy Outlook. The rewards for investment into low-carbon energy sources and technologies are therefore considerable. Areas of focus include: renewable energy, energy efficiency & storage and electric vehicles. Then there is the production of new low-carbon fuels such as hydrogen and, potentially, carbon removal solutions.

As asset managers, we have a critical role to play in providing finance for the transition to a low-carbon economy. We also have a responsibility to all our clients to consider how climate change will impact the value of their investments.

For our part, assessing the risks and opportunities of climate change forms a core component of our investment research and approach to environmental, social and governance (ESG) integration. Through engagement, we also seek to steer companies towards ambitious targets and sustainable low-carbon policies. Further, we collaborate with others, such as the Institutional Investors Group on Climate Change, to can help effect change and support better disclosure.


Final thoughts…

Climate change is one of the most significant challenges of the 21st century and has big implications for investors. Countries have started to act. The energy transition is underway in many parts of the world. We are seeing policy changes, falling costs of renewable energy and a change in public perception. But we all need to do more to meet the targets set out in the Paris agreement. While challenging, this will create huge opportunities for businesses, economies and investors. The price for inaction, however, will be immeasurable.


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