InvestmentsOct 21 2015

Climate rules and investment policy sea change

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The objective is to achieve a legally binding, globally recognised agreement to reduce greenhouse gas emissions and limit temperature increase to 2°C above pre-industrial levels.

In order to achieve this, only a limited amount of carbon dioxide can be emitted globally until 2050, meaning nations will have to agree to some form of carbon tax.

From an investment perspective, this will have to be factored into business plans and portfolio mixes.

A recent Towers Watson report also pointed out that existing targets already mean that only one-fifth of proven fossil fuel reserves can be burnt, rendering those reserves left in the ground uneconomical to exploit and deemed ‘stranded assets’.

Harald Walkate, head of responsible investment at Aegon Group, explains that there are both risks and returns from the likelihood of government regulation on climate change.

“Action in the shorter term on emissions and carbon taxes are increasingly likely and will be much more drastic than even a few years ago,” he stated, citing strong words from the Bank of England’s governor Mark Carney last month.

Speaking in terms of the insurance industry, Mr Carney says that there are three broad channels through which climate change can affect financial stability – physical risks, liability risks and transition risks – with the last one including changes in policy and technology which could prompt a reassessment of the value of a range of assets, as costs and opportunities become apparent.

He called on firms to publish information about their climate change footprint and how they manage their risks for a 2°C world, something which could encourage a “virtuous circle of analyst demand” and greater use by investors in their decision making.

There are of course many charities, think tanks and political parties pushing the environmental movement forward, but as the business case becomes ever more apparent, ever more investors and companies are also getting on board.

Fiona Reynolds, managing director of UN’s Principles for Responsible Investment initiative, notes: “Investors have a crucial role to play in tackling climate change, including working closely with policy makers to improve company disclosure and risk management.”

Jane Ambachtsheer, partner and global head of responsible investment at Mercer, says that she sees a growing number of asset owners and investment managers looking to integrate climate change risks and opportunities into their approach.

She says: “This is resulting in more questions for managers, including requests for carbon footprinting of investment portfolios. It is also driving increased interest in more niche strategies, focused on themes such as energy and resource efficiency and water, which can help to make global equity portfolios more climate-resilient.”

Impax Asset Management’s head of environmental, social and governance Lisa Beauvilain comments that while sustainable investment managers are already well positioned, many mainstream firms are beginning to align their strategies as well.

She explains that on the institutional side, companies are responding through internal pricing of carbon to assess the viability of future projects, while on the retail side it is more activist investment around ESG factors.

“There’s something of an ‘allergic reaction’ to glossy ESG reports, investors want genuine transparency and access to more raw data. I hope we’re moving towards a framework of more relevant and material risk information, so we can make more informed decisions.”

Peter Michaelis, head of equities and also head of sustainable and responsible investment at Alliance Trust Investments, says organisations like the Carbon Disclosure Project can help managers engage with companies on these issues, enabling better assessment of portfolio risk in terms of readiness for carbon pricing.

As for finding returns driven by climate change, he reckons it pays to be picky. “Things like LED lighting and efficient building materials give quite a quick payback, whereas other energy renewable technologies still rely on subsidies and are still working towards achieving sufficient scale,” Mr Michaelis notes.

Mr Walkate adds that from Aegon’s point of view, green technology investment is easier said than done. “The methods are relatively new and often not the type of risk or size of investment we’re willing to take, especially given our liability profile.”

Axa Wealth’s head of investing Adrian Lowcock says the performance of ethical benchmarks over the last five years has been better than non-ethical counterparts, something driven by the poor performance of oil and mining sectors over the last few years, along with the outperformance of smaller and mid-sized companies.

However, Tilney Bestinvest managing director Jason Hollands points out that despite strong performance, Investment Association recognised funds with ‘ethical’ mandates total just £9.95bn of assets – or 1.2 per cent of the wider industry – and have remained stubbornly anchored around that level for the last decade.

“The lack of cut-through for ethical investment over many years is really quite surprising when you look at other industries, where it is clear that sections of the public are willing to adjust their economic activity to reflect their values,” he opines, adding that the sector needs to address some common misconceptions to reach its full potential.

Peter Walker is senior reporter of FTAdviser.com