Positioning a portfolio for climate transition

global perspectives

Positioning a portfolio for climate transition

Hubert Keller - Managing Partner

Hubert Keller

Managing Partner
Christopher Kaminker, PhD - Head of Sustainable Investment Research & Strategy

Christopher Kaminker, PhD

Head of Sustainable Investment Research & Strategy
Didier Rabattu - Head of Equities

Didier Rabattu

Head of Equities

Increasing physical manifestations of an already damaged climate draw stark attention to the scale, scope and urgency of a climate transition. This transition is already underway and is creating transition-related risks and opportunities across sectors that stand to accelerate abruptly.

The unprecedented scale of investment required for the climate transition will also enhance economic growth prospects. Achieving the goals of the Paris Agreement requires that we maintain the global temperature rise well below 2°C above pre-industrial levels (and pursue efforts to limit the temperature increase to 1.5°C), even as the population continues to rapidly grow and urbanise. 

Keeping pace with these requirements will require a shift in the allocation of existing resources and additional incremental investment. Close to USD 100 trillion cumulatively1 will be required over the next fifteen years across all sectors to keep pace with this economic and environmental transition. 

Additionally, the OECD estimates that combining economic reforms with ambitious climate policies could boost GDP an average 2-3% per year by 2050 across the G202, or 4.7% accounting for the positive impacts of avoiding damage from climate change. This will require both a doubling of investment in infrastructure to meet the demands of economic and population growth over the next decade, and also a shift in investment flows to more climate-compatible infrastructure, aligned with a 2°C world.

The climate transition is already underway and is creating transition-related risks and opportunities across sectors that stand to accelerate abruptly.

Adapting to a warmer climate, and mitigating the risk of catastrophic environmental damage will require a monumental, concerted effort from all sectors, including those where emissions are harder-to-abate, but which remain essential to generating economic growth.

Meeting the goals of the Paris Agreement will require significant additional investment to prepare legacy carbon-intensive sectors like transport, energy, agriculture and industry for survival in an increasingly carbon-constrained world. We believe indiscriminately excluding these sectors to reduce a portfolio’s carbon footprint fails to capture the scientific, social, economic and financial necessity of pursuing environmental improvements in these critical sectors and is therefore unlikely to achieve investors’ financial objectives in the long-term. 

Addressing the needs of a net-zero economy means fundamentally addressing these hard-to-abate sectors. Without this, the transition to a net-zero economy cannot be achieved.

 

Drivers of the transition

Even so, the transition to a low-carbon and climate-resilient economy has already begun. The transition is driven by several powerful and self-reinforcing dynamics. While current global policies fall well short of delivering net-zero by 2050, many national policies are aligned, or at least at preliminary levels of discussion, to embrace this goal. Regions are also taking the lead, with the EU unveiling its Green Deal at the end of 2019 that commits it to becoming the world's first climate-neutral continent by 2050. Even where governments may lag behind (for instance the US), many sub-national cities and businesses are aligning their targets with net-zero.

Meanwhile, market forces are overtaking policy as a key driver of transition as innovation and increasing economies of scale rapidly change economic realities. Economics are now in the driving seat of the transition, powered through a catalytic positive feedback loop of cost declines and increasingly compelling economics for low-carbon solutions such as renewable energy. Consumer preferences are changing, channelling spending power towards more sustainable brands, food choices and lifestyles, and raising reputational risks for those who do not toe the line.

Investors, who have trillions of dollars at stake in the climate transition, are also pushing companies to adopt strategies aligned with both a carbon-constrained and climate-damaged world. For instance, in 2019, the International Accounting Standards Board (IASB)3 joined a long list of over 60 official sector authorities, central banks and regulators to weigh in on climate-related financial risks4, stating that climate risks are material for many companies’ reported assets and liabilities, and therefore for future corporate profits, thus highlighting the necessity of quantifying and disclosing these risks.

In combination, these forces create a significant growth opportunity for companies across multiple sectors that embrace the transition, either by providing solutions to adapt to a climate-damaged and carbon-constrained world, or by re-positioning themselves to generate competitive advantage. 

Those at the forefront of the climate transition are likely to grow their market share and outperform poorly positioned peers. Those that bury their heads and fail to adapt are likely to find themselves starved of customers, capital and talent and face existential threat.

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The world is already decarbonising – but the transition needs to accelerate. Some USD 5.5 trillion of investment will be required annually over the next decade to generate sustainable economic growth, and to align with the Paris Agreement and UN SDGs. Market forces are now in the driving seat of the transition.

 

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sources.

1 LOIM estimates and forecasts. Based on data under the sustainable development scenario of the IEA World Energy Outlook (2019) and Oxford Economics Global Infrastructure Outlook (2019) 
2 OECD Investing in Climate, Investing in Growth (2017). Accessed here https://read.oecd-ilibrary.org/economics/investing-in-climate-investing-in-growth_9789264273528-en#page10
3 https://cdn.ifrs.org/-/media/feature/news/2019/november/in-brief-climate-change-nick-anderson.pdf?la=en
4 See for instance the Central Banks and Supervisors Network for Greening the Financial System (NGFS) is pleased to announce it has grown from eight founding members to 54 members and 12 observers.

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