Less than one month before the United Nations Climate Change Conference in Paris, Cop 21, climate change is a topic gaining traction as a global policy initiative, a key risk factor and an emerging investment theme.
Cop 21’s goal is to achieve a legally binding agreement to keep global warming below the threshold of 2 degrees Celsius, the level that most scientists say is a critical one. This may pave the way for policy shifts that could ripple across multiple industries. The resulting regulatory risks are becoming key drivers of investment returns. In addition, more and more clients are expressing their interest in assessing climate risk in portfolios in order to reflect their values and deliver a long- term positive impact on the world.
Thus far, most countries globally have pledged to reduce emissions after 2020. China has committed to lower from 60% to 65% of its emissions intensity by the year 2030, and in Latin America, México and Brazil expect to lower their emissions by 22% and 37% respectively by the same time.
Things are changing for corporations and markets too. Today, some international financial regulators appear to be moving towards ultimately incorporating an assessment of climate risk into accounting standards. Securities markets also evolving to include emissions trading and green bonds, enabling investors to limit carbon exposures in portfolios and direct capital to projects that reduce emissions. In the corporate world, environmental, social and governance (ESG) factors, which are a way to promote sustainability, are also becoming a mark of operational and managerial quality.
What are investors doing to adapt portfolios?
Across the world, institutional investors managing $24 trillion in assets signed the Global Investor Statement on Climate Change in 2014. In it, they committed to manage climate change risk as part of their fiduciary duty to clients. Impact on sustainability can be achieved in three ways:
- Prevent: Screen out securities that do not align with their values, such as those of issuers in the fossil fuels, tobacco or arms industries. Norway’s parliament, for example, has voted to divest coal assets from its sovereign wealth fund.
- Promote: Focus on companies with strong environmental, social and governance (ESG) track records and integrate ESG factors into the investment process. Sustainable investment portfolios are an example.
- Advance: Target outcomes that have a measurable impact on the environment. Examples include direct investments in renewable or energy-efficient projects and green bonds.
The rise of the importance of climate change considerations is impacting the way investors think about their investments and portfolios. And, as regulatory frameworks harden and/or the impact of climate change on the environment becomes more apparent, asset prices will be likely impacted.
Yet, many of these potential outcomes (think for example, of the long term effects of greenhouse gas emissions) are harder to predict and therefore to price in. Insurance companies have been at the forefront of climate risk pricing given their exposure for example to natural disasters, but many equity and credit investors still ignore this risk when building portfolios.
Admittedly, this has not been historically necessary. When looking at monthly returns over the last 20 years in the MSCI World Index there has been no climate change risk premium for equities. But the future might be different from the past in this case, and as client’s requests evolve and the regulatory burden increases, impact considerations may become more important in investment decisions. This is not only about ‘doing good’, it’s also about investing in companies that evolve with market trends, are able to adapt their businesses to future challenges and often have more engaged and productive employees.
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This material is for educational purposes only and does not constitute investment advice nor an offer or solicitation to sell or a solicitation of an offer to buy any shares of any Fund (nor shall any such shares be offered or sold to any person) in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities law of that jurisdiction. If any funds are mentioned or inferred to in this material, it is possible that some or all of the funds have not been registered with the securities regulator in any Latin American and Iberian country and thus might not be publicly offered within any such country. The securities regulators of such countries have not confirmed the accuracy of any information contained herein.