Feb 18, 2020
From record temperatures in the Antarctic to the row over the presidency of the UK-hosted COP26 climate talks, it’s easy to become despondent about climate change. In fact, psychologists warned last week that the pile-up of worrying climate news could be stoking a mental health crisis.
Yet amid the scary headlines, the massive changes taking place to decarbonise the global economy often get overlooked. There’s an enormous amount still to do to meet emissions targets. But we believe there are at least three reasons for investors to think (and act) positively. After all, negativity will get us nowhere – it’s time for forceful, positive action on climate change.
Political and business momentum is becoming unstoppable
We’re starting to see political responses to climate change that would have been unthinkable a few years ago. European industrial policy is now based entirely around the low-carbon economy, with the bloc’s leaders looking to halve emissions by 2030 – a commitment that will require €260 billion of investment per year in energy, transport and construction. Meanwhile, the UK has brought forward a prohibition on the sale of petrol and diesel cars by five years to 2035 at the latest, and included hybrids in the ban for the first time.
The response from some sections of the business community has been equally impressive. Confounding most forecasts, new data shows that global carbon emissions from energy plateaued in 2019 as developed economies abandoned coal in favour of wind, solar, natural gas and nuclear — the first time in a decade that carbon emissions from energy have not increased. Meanwhile, UK energy providers generated more electricity from zero-carbon sources in 2019 than from fossil fuels, for the first time since the industrial revolution.
This acceleration of climate action is widening the opportunities for investors. We think there are some great decarbonisation enterprises with solid business models, impressive technologies and defensible competitive positions. Of course, there are also companies that don’t have these attributes, which is why we recommend a highly selective approach. But the assumption that a climate-focused portfolio need be high risk is totally outmoded, in our view.
In fact, we’d argue quite the reverse: that a well-constructed environmental portfolio can help balance the climate risk in other investments. What’s more, investing in decarbonisation companies should have a positive impact by aiding the transition to a lower-carbon economy.
The focus is shifting to positive investment
There are also encouraging signs that more investors are recognising that divesting from carbon-intensive businesses is not, by itself, sufficient. Investec’s recent Planetary Pulse survey found that investors are keen to use their savings positively to help tackle climate change. Some 61% of UK pension fund members said they would be willing for a proportion of their workplace pensions to default into environmental investments.
That’s good news because, as the director of the United Nations Environment Programme says, "we need to catch up on the years in which we procrastinated." ‘Catching up’ means a massive and immediate acceleration of efforts to tackle climate change, or else the 1.5C goal will be out of reach by 2030.
This shift in emphasis towards positive investment is good for the planet, because it raises the likelihood of meaningful action being taken. It’s also good for investors in decarbonisation, because it will strengthen the tailwind behind the businesses that are shifting the global economy to a lower-carbon model. Specifically, we need to spend heavily on: transforming our energy infrastructure; electrifying transport and other systems; and vastly improving energy efficiency. There are investment opportunities across all three of these pathways to a lower-carbon world.
The risk of positive shocks may be rising
Though worrying from a planetary point of view, there is a positive investment case to be made from the fact that current efforts to tackle climate change are “utterly inadequate”, according to the UN. We’re spending only about one-quarter of the US$2.4 trillion required each year to stop temperatures rising dangerously. That’s already driving growth for select businesses, but the additional spending required to achieve the Paris Accord emissions targets would put their growth into hyperdrive.
It remains to be seen whether the full investment will be made. But the UN’s dire assessment increases the likelihood of regulatory, technological or consumer-choice shocks to get emissions on track. Such shocks would be positive for decarbonisation companies and negative for businesses with high climate-risk exposure. To illustrate the growth potential of decarbonisation businesses, cutting emissions sufficiently to achieve the 1.5C goal would mean increasing wind and solar’s share of the energy mix from 7% to 70%. The proportion of electric cars on the road would need to reach 100%. That isn’t our base case but, after a torrid 2019 for the electric-vehicle value chain, we think 2020 could mark a turning point for the electric car.
As an aside, these shocks would only be felt meaningfully in listed equities, which immediately price in changes in expected growth. Green bonds and private infrastructure – other ways that investors might seek exposure to decarbonisation – won’t respond in anything like the same manner, largely because their returns are contracted, which makes their valuations fairly stable.
Let’s close with one more positive for investors. Our analysis shows that the consensus is forecasting lower growth for decarbonisation companies than for the market overall. To us, that makes no sense. But it also suggests opportunities to invest in businesses whose potential the market is yet to recognise. If that doesn’t sound like a reason for investors to look forward more positively, we’re not sure what would.
All investments carry the risk of capital loss.