'Overlooking the impact of Cop28 would be a mistake'

This pivotal summit arrives amid global upheaval, where immediate crises from regional conflicts to economic turmoil in the wake of a pandemic vie for the world's attention.

Yet, for astute investors, the dialogues within Cop28's forums bear significant consequence, for therein lie catalysts capable of recalibrating the financial landscape. 

The convocation at Cop28 broaches 'finance' as a cornerstone theme, recognising that capital allocation is instrumental in realigning our trajectory towards the aspirational 1.5 per cent climate target.

The decisions and discussions that will crystallise into the conference's final edict are not merely environmental pledges, they are determinants of economic reorientation that could reconfigure the portfolios we steward. 

At what will inevitably be billed as one of the last chances to avert climate disaster, participants will struggle to attract the attention of a world focused on the horrific situation in the Middle East, ongoing war in eastern Europe and the economic challenges of a post-Covid world, all of which appear more urgent and tangible to those being discussed at Cop28. 

The realm of investing is governed by the probabilistic evaluation of various scenarios.

While it would be easy to overlook Cop this year, this would be a mistake from an investor’s perspective as this event has the potential for meaningful change that could impact the companies that comprise investor portfolios.

Finance is one of four cross-cutting themes for the conference, alongside technology and innovation, inclusion, and frontline communities, and consequently the allocation of capital to support a return to a 1.5 per cent trajectory is expected to key to the discussions and negotiations leading to the final conference text.

To navigate Cop28's potential reverberations through the marketplace, investors must adopt a discerning lens, tempering optimism with pragmatic foresight. It is incumbent upon us to eschew conflating our aspirational vision for the summit's outcomes with the pragmatic probabilities of actual events.

The realm of investing is governed by the probabilistic evaluation of various scenarios, not the least of which includes the seemingly intransigent path of inaction.

Nonetheless, we must also ascribe due weight to the less likely, yet pivotal, scenarios wherein Cop28 might indelibly impact global economic structures and, in turn, asset valuations.

Failure to take account of lower probability outcomes results in surprises, which in turn lead to the greatest and most predictable investing mistakes.

A precedent for such pivotal moments is the unexpected progress in establishing a loss and damage fund preceding Cop28 – progress that, while tangentially touching the investment community, underscores the potential for unforeseen advancements.  

Investors, in assessing the implications of Cop28, must remember that asset prices are influenced through three primary channels: cash flow alterations, volatility shifts, and investor sentiment.

For instance, an intensified agenda for the phasing out of fossil fuels may truncate cash flows to traditional energy sectors, reshaping the fundamental valuation of such enterprises. 

Similarly, regulatory certainty, exemplified by the Inflation Reduction Act of 2022 in the US, can mitigate cost of capital by solidifying future operating contexts for businesses positioned to thrive within such frameworks.

While it is very unlikely that Cop could achieve anything on that scale, any strides toward policy clarity could influence the discount rates for future cash flows, enhancing business valuations.  

The challenge for investors when incorporating these fundamental changes is that we are naturally myopic in our investment outlook; we tend to focus on the immediate impact of any change and typically underestimate the long-term consequences.

The strength of this reaction can precipitate misalignments between asset prices and their intrinsic value, especially when outcomes defy expectations.

Consequently, the third way that Cop can impact asset values is via the sentiment of investors.

We tend to focus on the immediate impact of any change and typically underestimate the long-term consequences.

For example, a failure to address the lack of promised capital flowing into emerging economies to support carbon transition may lead to more negative sentiment towards investing in emerging economies at a time when investor appetite for emerging market assets is already weak. 

However, such disconnections between price and value also provide opportunities for longer-term investors to achieve above-average returns by looking beyond the prevailing sentiment to the fundamental change that lies behind it and investing in assets that are currently unloved. 

These three mechanisms for price change can serve as a checklist for investors when assessing the news that emerges from Cop28. Unless policy shifts substantively affect an asset's cash flow or significantly recalibrate investor sentiment, their relevance to the investor may be minimal.  

Having established the pertinency of possible changes, the next step is to assign probabilities to the impact of those changes. It is likely that our estimate of these probabilities will evolve over time as more detail is revealed, but by using this approach we are equipped to forestall surprises and make sound decision-making.    

As Cop28 unfolds, while we might harbour hopes for transformative strides in the climate arena, as investors, our mandate is to appraise the world through the unvarnished lens of the current reality, not through the rose-colored glasses of what we might wish it to be.

Dan Kemp is chief research and investment officer at Morningstar Investment Management Europe