Climate change continues to be a controversial topic, but how should level-headed investors respond?
President Obama helped drive the issues of climate change to the top of the international agenda in the run up to the Copenhagen Conference on Climate Change in December last year.
Many observers were hoping for great things. Some were predicting a legally binding international agreement on international emissions reductions. Unfortunately, in the end, Copenhagen failed to deliver. Many have pointed the finger at China’s blocking tactics. Some also believe the controversial hacked emails that emerged on the web regarding some of the University of East Anglia’s academic research, which appeared to suggest the academics were subverting the peer review process and denying freedom of information requests. Since then, attention has moved on to the International Panel on Climate Change’s peer review process letting slip claims on the Himalayan glaciers melting faster than they are.
Farce or tragedy?
However, while elements of the Copenhagen Conference were certainly farcical – particularly the logistics, with some delegates queuing for 10 hours in the snow – it is easy to forget the conference generated a number of commitments from around the world.
While these national commitments fall a long way short of dealing with the global problem of climate change, they remain a modest step in the right direction. Similarly, what many commentators have overlooked is despite the noise on the controversy, the broader science remains solid (for example, the IPCC inaccuracy on the melting Himalayas did not appear in the policy maker summary, nor does it change their overall findings). What matters most to investors is how those nations now respond to the science. We need to watch how nations enact their commitments within their national policy framework. We expect to see progress in the US, China, Japan, India and Australia in the near term.
Prospects
As for the prospects for an international agreement, the Copenhagen Conference was attended by an unprecedented number of heads of state, many of whom argued climate change was among the most important issues that required their attention.
While expectations for the Conference of Parties in Mexico (COP 16) later this year are currently much lower than the optimism that surrounded Copenhagen, the reputation of heads of state has suffered. It will be difficult for them to argue that climate change is no longer important.
How Copenhagen failed
The failures of the Copenhagen Conference, including the lack of binding international emissions targets and no indication of the point at which emissions need to peak, is an issue for long term investors. Lord Stern’s assessment of the economic impact of climate change highlights that the recent financial crisis, serious as it was, pales in comparison to the dangers of runaway climate change.
His Review on the Economics of Climate Change in 2006 made it clear climate change could represent a significant cost to the global economy. Its main conclusions are 1% of global GDP is required to be invested a year in order to mitigate the effects of climate change, and failure to do so could risk global GDP being up to 20% lower than it otherwise might be. The climate is without question the most important contemporary example of a range of natural resources that will cause complex and profound economic development issues if used unsustainably.
Internalising external costs
In spite of Copenhagen, it remains our belief external costs such as carbon emissions will become internalised into company profits and balance sheets over the next several years. While investor sentiment on companies providing renewable energy and energy efficiency products has been knocked, the fundamentals of the climate change science remain unshaken. This is also the case for the fundamentals of these companies as their cashflows are driven much more by national policy than international deals. For example, among the many companies we believe will benefit are companies like Hansen Transmissions, Phoenix Solar, SMA Solar, PV Crystalox, Iberdrola Renovables, and Sheffield Insulation. We believe they are sound investments and, where appropriate to the mandate, we continue to hold them for clients.
A step back
Stepping back from the detail, for investors and their clients, choosing the right SRI fund or individual stocks can be daunting. However, there are a few quick questions that can be asked of fund managers that can help discern whether they are aware of the issue and working on it:
1. Is the fund manager factoring in climate risk to their investment analysis and adjusting the portfolio accordingly?
2. Is the manager engaged in promoting stronger government policy action via initiatives such as the Institutional Investor Group on Climate Change?
3. Does the fund manager promote better corporate management and disclosure of climate change via the Carbon Disclosure Project?
4. Does the fund manager vote against the report and accounts of some companies where climate change is a material risk but they are not disclosing?
5. What resources does the fund manager invest in this work?
Another place for investors and their advisers to go to is EIRIS. EIRIS is an independent research company focused on the environmental, social, governance (ESG) and ethical performance of companies. Their aim is to provide information that empowers responsible investors and to develop the market in ways that benefit investors, asset managers and the wider world. EIRIS classifies companies into over 50 sectors (and sub-sectors) based on business activities. Each sector is defined as having very high, high, medium or low climate change impact based on its direct emissions (i.e. operations) and indirect emissions where companies have control and not just influence (e.g. supply chain).
Momentum for change
For those investors wanting to look to invest in companies or with fund managers that are concerned about the impact we are having on the environment, the Copenhagen Conference was a disappointment. However, we believe the momentum for change remains to establish greater certainty around the global response to climate change. There is strong commitment from a number of political leaders and despite the lack of progress at Copenhagen, the issue has not gone away. We expect to see much more serious movement in this area over the coming years.
