Reconciling values and returns with sustainable investments
The proportion of renewable energies in the electricity market is steadily increasing. Today, 62% of the electricity from Swiss power sockets comes from hydropower, photovoltaics, wind power and biomass. Switzerland’s goal: to have completely abandoned the use of fossil fuels by 2050. Sustainable investment strategies make it possible to promote climate protection whilst generating returns at the same time.
When sustainable investment strategies first emerged, the focus was often on companies that targeted a particular environmental problem and solution: reducing pollutants, improving water and air quality or tackling carbon emissions.
Now there’s a new sustainability factor that investors are starting to consider: What’s the potential negative impact of climate change on companies themselves — and how can investors evaluate those risk factors in terms of their investment outcomes?
These questions have become more pressing as natural disasters like hurricanes, floods, droughts and fires have become a more prevalent and growing threat to the sustainability of company operations. Business leaders worldwide are being forced to cope with everything from regulatory changes to supply-line disruptions. Indeed, in the 300-plus cities around the globe that generate more than half of the world’s GDP, it is estimated that the impacts of climate change will place $1.5 trillion of this production at risk by 2025.
Fortunately, at the nexus of these business and environmental challenges, a new branch of analytics is launching. Established enterprises and emerging new players in this field are helping investors assess the risks associated with climate change on company performance. Extreme weather events, natural disasters and the potential failure of climate-change mitigation top the World Economic Forum’s 2018 survey of global risks with the highest potential likelihood and impact.
Risk and opportunity heat up
A leader in this growing sector is Carbon Delta, a financial technology company co-founded in 2015 by Oliver Marchand. It has built a proprietary database to measure the climate change risk and opportunity of some 22,000 companies across the globe. “Some people call the low-carbon transition the fourth revolution,” says Marchand. “This comes with huge business opportunities — and, for some companies, risk. We seek to make both possibilities more transparent.”
Take the impact of global warming. The Paris Agreement, which was adopted by 195 countries in 2015, imposed the goal of keeping the increase in global average temperature to less than 2 degrees Celsius above its preindustrial level. But the corporate cost of achieving that goal can be high. Marchand says that within one broad global equity index, Carbon Delta’s model finds that about 7 percent of the companies are at risk of losing more than 30 percent of their market capitalization if they bear the full brunt of regulatory costs to reduce their emissions.
On the flip side, based on Carbon Delta’s analysis, about 5 percent of the companies could see an upside of more than 30 percent simply because their business is positioned to benefit from providing lower-emission products or services.
In addition, Marchand says the G-20’s 2017 issuance of recommendations for climate-related financial disclosure could be “a really big deal” in pushing climate change transparency, as it provides a framework for regulators to consider advancing the G-20 proposals into actual policy.
Creating a climate change awareness index
More than a decade ago, recognizing the importance of sustainable economic development as a global growth trend, UBS began to build its own database of an individual company’s exposure — both as opportunity and risk — to climate change and other sustainability factors. The sustainability analysis is woven into UBS’s asset management offerings for institutional investors.
Over the past year UBS has launched institutional Climate Aware Funds in Switzerland, the United Kingdom and the United States that adjust a broad benchmark index — overweighting and underweighting companies based on how they are addressing climate change.
That underweight/overweight strategy is also being used by a U.K. pension fund that tasked UBS with reducing the carbon emission footprint of a stock portfolio while continuing to earn a long-term return that would track the portfolio’s benchmark index.
“A negative tilt is used to reduce the size of the investment in companies with lower-than-average greenhouse gas emissions, energy derived from coal and large reserves of coal, oil and gas,” explains Michael Baldinger, Head of Sustainable and Impact Investing at UBS Asset Management. “A positive tilt is used to increase the size of the investment in companies providing renewable energy or supporting related technology, and performing in line with the transition to a low-carbon economy.”
An important feature in the UBS approach is that the current carbon footprint of a company is not a disqualifying factor for engagement. Baldinger says that a simplistic approach risks missing more complex stories where risk and opportunity are rolled into one stock. “Some oil industry leaders are among the largest investors in alternative energy,” says Baldinger. Moreover, UBS wants to retain a seat at the table as a shareholder in sectors such as fossil fuel production in order to support positive change.
“Anyone who simply excludes this sector is unable to exert any influence through their investments on the means and timing of such a transition,” says Baldinger.
On the positive tilt side of the investing strategy, Baldinger says current investment opportunities extend across many sectors, from utilities focused on renewable energy to industrial companies producing products and services that feed demand for solutions.
He says that reducing the pace of climate change over the long term requires a diverse response from all corners of the global economy. Fossil fuel companies, he adds, must consider more environmentally friendly options, and industrial sectors must commit to reducing greenhouse gas emissions across production and supply chains. In addition, products for industry and consumers need to focus on delivering energy efficient goods and services to end users.
Global business got a big nudge on those fronts three years ago. “The Paris Agreement serves to crystallize climate as a key investment risk,” Baldinger says. “The associated risks extend right across the investment universe, from equities through to corporate bonds, property and, potentially, government bonds.”
UBS’s melding of sustainability and fundamental analysis into its portfolio management aims to help investors navigate the investment risks and opportunities created by heightened global awareness on climate change.
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