December 5, 2019

Climate change to affect asset prices with little warning

Climate change is a long-term problem, but when it starts to affect asset prices it will happen very quickly, experts told the recent 2019 Association of Superannuation Funds of Australia.

Climate change is a long-term problem, but when it starts to affect asset prices it will happen very quickly, experts told the recent 2019 Association of Superannuation Funds of Australia.

In a session titled Driving the sustainability agenda, a panel of investment managers considered how investors and others in the financial system can properly consider and account for the long-term impacts of their corporate and investment activities on climate, the environment and the social fabric.

These ideas are generally not factored into the calculations involved with investment decision making, which instead focus on GDP, company earnings, share prices and the like.

The panel heard that one of the challenges of taking climate change into account is that it is a long-term problem and investors can risk thinking they can adjust portfolios when they get more information.

“But with these things what happens is that people ignore them, and by that time [investments] have lost much value,” an investment manager said.

Investors need to take a long-term view, but also understand that things can change very quickly.

“When you think about the climate, there’s a lot of information around disruptions that we should be looking at,” the audience heard. “We know, for instance, the cost curve of renewable energy generation and the cost curve of batteries has been falling rapidly. You could reasonably predict the trajectory over a time horizon, that is not infinite, within five years.”

Climate risk a rachet risk

One investment manager described climate change as a “rachet risk”. Unlike the risk in an equities market, which if it suffers a fall can generally be expected to recover in the future, where as the effects of climate change compound the more they go on.

The panel also provided an update on the Australian Sustainable Finance Initiative (ASFI), which will set out a roadmap for realigning the finance sector to support greater social, environmental and economic outcomes for the country and aim to produce a report in the middle of 2020.

The group draws in 130 representatives from the finance sector, the government, regulators, academia and indigenous Australia, and is aiming to produce something that is implementable, “not just a report that will sit on the shelf”.

Many other nations have already produced their roadmaps and as a result ASFI can learn from their lessons. In particular, the panel heard, it is not enough to focus just on the global Paris Agreement emissions reduction.

It will also incorporate the UN’s social development goals, which the UN describes as 17 global goals designed to be a “blueprint to achieve a better and more sustainable future for all”.

“What the other roadmaps haven’t done is integrated the social transition with the climate change. And so we’re looking at that as well,” the audience heard. “When you’re focused only on the Paris agreement, that’s when people get left behind.”

The report will also consider the taxonomy of investments and financial instruments, to ensure everyone has the same definitions and can be confident about what they’re investing and, and data – what is useful data and how it should be interpreted.

Past performance is not a guarantee of past performance

The old investment adage of “past performance is not a guarantee of future performance” is well-known, but the audience was given a variation: “past performance is no guarantee of past performance”.

What this means is the true cost of production of economic activity was actually understated because it wasn’t factored into the earnings of the organisations that we’ve been investing in, and hence profits have been overstated.

“As consumer behaviours change and we become more aware and able to measure and target and explicitly be mindful of externalities, I would expect returns to be lower in the future in aggregate,” one panel participant said.

There is an opportunity for investors not only to create wealth, but also to create economic and societal benefit in their asset allocations.

But holding this back is how investors are trained, to take very complex businesses that deal with customers, markets and choices and distil them down to 10 or so metrics. They also confine themselves to existing assets rather than thinking about new ideas or opportunities.

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