Talking about climate change is fashionable again. In the year when the concentration of carbon dioxide in the atmosphere touched 400 parts per million for the first time in human history, President Obama has finally elevated the topic to be amongst his priorities.
So what does this mean for the financial community? Institutional investors who are inclined to be cynical about climate change are probably picking the wrong answers to five key questions.
First, isn’t the science too uncertain to act? No. Over the past five years, the scientific consensus has concluded resolutely that human emissions of greenhouse gases are heating the planet and will continue to do so. There is uncertainty over the rate of warming and the effect of feedback mechanisms, especially clouds, so future climate and weather conditions can only be thought of in terms of potential scenarios. Yet investors are trained to make decisions around a range of outcomes.
Second, can’t investors take a “wait and see” approach? No. Although the most likely climate scenarios suggest that catastrophic climate change may be decades away, companies and governments are likely to act with increasing determination to reduce carbon dioxide emissions, often with scant regard for the value of investors’ carbon-related assets.
Third, won’t climate change affect just a small part of a typical investment portfolio? No. Climate change affects almost every part of a portfolio. New emissions policy that depresses returns for coal power generators will of course impact utility assets and coal-mining stocks. Higher energy prices are likely to harm companies producing basic materials such as steel, cement and chemicals. But what about the effect of changing patterns of disease on the portfolios of pharmaceutical companies, the increasing incidence of extreme weather events on infrastructure, or the impact of changing climate patterns on timber assets? Investors need to consider the full range of options.
Fourth, isn’t climate change just a risk issue? No. Investors certainly face direct risk of more severe weather, indirect risk that climate change policy will reduce asset values, and reputational risk that their stakeholders are unhappy with a “do nothing” response. Impax and FTSE have identified over 1,000 listed companies for which a majority of their business is derived from markets linked to climate change and related resource-efficiency themes; by tilting their portfolios toward this growing set of opportunities, investors can create a natural hedge against climate-change-related risks.
Finally, isn’t it sufficient just to put climate change on the radar? No. A typical pension fund investor may be tempted to ask the appointed external managers to keep on the lookout for climate-change-related opportunities. To do this effectively requires an experienced and specialist manager with a deep understanding of the issues around the climate science and its potential impact, together with the ability to identify and value the best technologies and growth opportunities. Only by consciously allocating to a new bucket at the portfolio level can the investor have a reasonable chance of establishing meaningful protection.
The recent financial crisis demonstrated that most investors are woefully unprepared for the unexpected -- the so-called “unknown unknowns.” Unlike a classic bubble that bursts catastrophically, climate change is a more complex issue that will impact portfolios through both incremental and quantum change. Investors who recognize this and plan accordingly are likely to outperform.
Ian Simm is the CEO of Impax Asset Management, an investment manager focused on opportunities created by the scarcity of natural resources and the growing demand for cleaner, more efficient products and services.