Climate Change

As financial markets continue to respond to policy changes and advances in climate change technology, we look at some of the opportunities and risks for investors brought about by the transition to a lower carbon global economy.

Marc Andre Lewis

Head of Portfolio Construction,
Strategy & Planning Department

The story of how climate change will affect global economies and financial markets over the next decade is likely to be a complex and nuanced one. Accepting this, and finding methods that both mitigate risks and capture opportunities, will be a key challenge for investors of all sizes.

At a macro level, financial markets are already being influenced by the increasing amount of capital deployed in line with climate change and Environment, Social and Governance (ESG) principles. This trend is certain to continue into the future.

Discussion is often too focused on identifying the companies deemed to contribute to climate change and then excluding them from investment mandates. This approach relies solely on current‑state data, and does not factor in the significant potential for companies to innovate and evolve to the needs of a global economy less dependent on fossil fuels.

Looking to the future, there are many uncertainties to consider. The pace of climate change is not pre‑determined and could be altered by a number of factors, most notably changes to government policy, regulation and the rate of technological change. The reaction of global financial markets, and companies themselves, to that undefined pace of climate change is also difficult to forecast. Accordingly, there is no easy split between those that will benefit and those that will suffer from the impact of a changing climate. One of the main goals of portfolio construction is to build the necessary resilience to manage uncertainty.

This is best achieved by ongoing and detailed scenario modelling that considers evolving market dynamics in the context of an investor’s specific objectives and investment horizons. When done well, this will allow investors to manage the downside risk of a changing climate by identifying negative scenarios and allowing them to plan accordingly.

The winners of a lower carbon future may not be clear for some time. Capturing the opportunities at an asset allocation level will require an ongoing assessment – and reassessment – of portfolio robustness combined with agile decision‑making, applied consistently over time.

Mujeeb Qazi

Head of Energy,
Real Estate & Infrastructure Department

Over the past decade, renewable energy has moved from a promising but still‑emerging technology to a viable and ever‑increasing part of the global energy mix. The outlook is positive for that growth to continue, although improving the consistency of supply will be the defining challenge for renewables over the next decade.

There is significant positive momentum behind renewable energy development and this will continue, driven by advances in technology – particularly for solar and wind power – and supportive government policies. Some studies suggest that by as early as 2020, the price of energy generated from commercially available renewable technologies will be at least equal to or cheaper than fossil fuels. Indeed, this is already the case in some markets such as India and Mexico.

However, reaching cost parity with power generated from fossil fuels is only half the equation. Renewable energy sources are intermittent: solar power can only be generated during the day, for instance, and works best in cloudless conditions.

A new generation of flexible gas turbines is likely to be part of an interim solution for future energy networks based primarily on solar and wind power. These turbines will act as a low‑emitting and cost‑effective option, able to meet the varying residual load requirements caused by intermittent renewable power generation. But without adequate storage technology, there will remain a natural ceiling on the proportion of base load energy renewable sources can supply.

Battery storage capacity is already growing rapidly, in large part due to demand from electric vehicles. However, the technology remains in its infancy and further advances are essential. If, as many expect, they are forthcoming, then renewables will continue their inexorable march towards eventually replacing traditional fuels entirely.

Brian Tipple

Global Head of External Equities,
External Equities Department

Climate change is having a gradual, rather than revolutionary, impact on public markets, but the pace of change is accelerating. As it does, investors are increasingly focused on climate change as a return driver, rather than principally an exercise in demonstrating social, regulatory or political sensitivity.

Over recent years, there has been strong growth in the number of ESG strategies available in the market. Investors now have a much larger number of ESG options to choose from and even conventional strategies are likely to begin incorporating these factors into their research process in the coming years.

Climate change is a driver of significant innovation for businesses, and real opportunities are emerging for companies and sectors to become early adopters – which capital markets tend to reward with higher valuations. Sometimes these are not the obvious candidates; for instance, industrial companies that are designing key components for new wind turbines.

For asset managers, climate change is moving from the periphery to a field that requires the development of highly concentrated strategies. These are based on deep research of specific markets, certain sectors and companies, to find stocks that align with demand created by climate change.

As ESG linked investments proliferate over the next decade, these products will be among the most interesting to watch. By targeting the ‘real world’ profit opportunities that exist for early adopters, they have the potential to attract investors across the spectrum, from those that invest for a social purpose to those that are purely driven by return considerations.