2020 looks set to see climate change become more widely recognised as an investment issue, creating an opportunity for active managers.
Sometimes when you come to write outlook pieces you are encouraged to think the unthinkable, to consider the new and the innovative. But often the most profound insights come from identifying the trends over the past 12 months that look like they will stick. My bold prediction for 2020 is that climate change will move from being a storm in a tea cup to making the investment weather.
There are three main reasons driving climate change’s move from simply “interesting” to actually impacting investments.
Growing public concern: We can see this most clearly in the Schroders Global Investor Study that we undertake for both retail and institutional investors on an annual basis. In 2019, institutional investors chose climate change as the number one engagement issue, trumping the previously favoured area of corporate strategy. Meanwhile, retail investors made it clear that they are prioritising the planet over other areas such as prosperity and people.
It is simply a matter of time before these preferences start to drive significant asset flows into climate-related investments. Yet although the number of climate change sceptics has diminished quite dramatically, those who see climate change as an investment issue are still in the minority.
Rising regulatory pressure: It’s not only the public that has woken up to the challenges posed by climate change. Financial regulators have the topic in their sights and while discussions regarding different approaches have been ongoing for some time, 2020 will see climate change formally entering the investment regulation arena. For example, the UK’s Prudential Regulation Authority (PRA) has introduced a climate change investment stress test for insurers and European regulators have indicated that they will shortly be following suit.
Furthermore, part of the EU sustainability finance package is to ensure that environmental, social and governance (ESG) risks and opportunities are embedded in investment decision-making structures. With this kind of regulatory pressure, it’s not hard to imagine that momentum will start to build for investors to change their portfolios as a result; after all, what gets measured gets managed.
Increased demands for corporate disclosure: Companies are being pressured into disclosing more on climate-related risks and opportunities. This can be seen in the growth of the number of organisations supporting the Task Force for Climate-related Financial Disclosures (TCFD) which now stands at 867 (as at September 2019). Japan has the most number of companies that have agreed to disclose against the framework.
As we get more disclosure, we expect investors to realise that the second order effects are far greater than they first envisioned. As our carbon value at risk work shows, total global equity earnings could be hit by up to 15% from transition risk alone. The spread between the winners and losers could be significant.
Transition risk is the financial risks that could result from significant policy, legal, technology and market changes as we transition to a lower-carbon global economy and climate resilient future. The sectors that are hit extend far beyond the extracting industries such as oil & gas and miners, and into airlines, building materials and industrial stocks.
However, climate-related risks and opportunities are not just confined to equities (shares). As some of our recent work on divestment showed, thinking of climate change in investment terms is about far more than just avoiding fossil fuel equities; we expect scrutiny to spread to debt markets holdings and bank loan books.
All of this creates a potential opportunity for active management. Climate change is widely known but poorly understood, particularly the knock-on effects. I think we will look back 10 years from now and view climate change investment risk as something that we “just live with” in investment terms, similar to how we’ve had to learn to cope with low interest rates over the past decade.
You may have thought that we had reached peak-Greta Thunberg and that climate change was a 2019 issue. My bold prediction for 2020 is that we have only reached the tip of the (quickly melting) climate change investment iceberg.
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