10 October, 2019

Cookie cutter approach to climate-friendly investing not for everyone

Human-caused climate change is expected to force significant adaptations in how businesses operate and what goods and services are provided. This makes things tricky for investors who have to work out what it means for investment returns. They also have to balance their need for good investment returns with their desires to do good for the environment.

Attitudes are changing

People are becoming increasingly aware of the responsibility humans have for climate change and the need to change behaviours to reduce climate harm. The Lifestyle of Health and Sustainability (LOHAS) group are at the forefront of the trend towards conscious consumerism, which is all about seeking a good life in a way that’s easier on the planet. Others are following suit.

Changes in consumer preferences are causing a shift of resources away from greenhouse gas (GHG)-emitting industries toward more climate-friendly industries. At the same time, pressure from consumers is encouraging companies with high GHG emissions to innovate in a way that reduces emissions and meets consumer desires.

Costs are rising

New Zealand’s Nationally Determined Contribution to GHG reductions under the Paris Agreement and its proposed emissions reduction targets in the Zero Carbon legislation will mean further government measures, such as regulations, taxes, and subsidies, to mitigate GHG emissions.

The Emissions Trading Scheme will be expanded and impact on a wider set of activities. Mounting climate-related obligations will incentivise lower GHG emissions, but will increase business costs and reduce the profitability of high-GHG emitting businesses.

Climate change risks to business are increasing

At the company level, boards and executives are becoming more aware of changing attitudes and their responsibilities to reduce the carbon footprints of their businesses. Reputational and regulatory risks to companies from not doing enough to reduce their GHG emissions are rising, especially as advances in climate science lower the bar for successful prosecutions of negligent companies.

In a 2018 survey of large global companies, carbon disclosure organisation CDP found that over 50% of companies identified climate-related risks with the potential to have a substantive financial or strategic impact on their business.

Climate change winners and losers not necessarily who you think

Due to its substantial economic effects, climate change will undoubtedly result in numerous investment winners and losers. These may not always be well signalled by the sector or industry they are in. For example, most of the big global oil companies are already dipping their toes into clean energy, and will increasingly do so in the future. In Europe, major oil companies are already responsible for around 70% of all renewable energy in the region.

Our own electricity generators have a high degree of renewable capacity, but some are more reliant on carbon-emitting generation than others. For the climate-aware investor, therefore, a more selective approach to investing may better meet their desired ethical outcomes than favouring or banning whole sectors or industries.

The rise of climate aware investors

Just as consumers are exercising their preferences for less climate harmful products, investors are increasingly choosing investments consistent with their wishes for greater care of our climate. Some Kiwisaver funds, managed investment funds and exchange trade funds (ETFs) have responded to investor demands by incorporating carbon-related criteria in their environmental social and governance (ESG) screens for responsible investments. The New Zealand Superannuation Fund is reducing its holdings of carbon-intensive companies to make its investment portfolios more resilient to the various risks posed by climate change. Some investment funds are taking climate-awareness even further by only investing in companies making a positive contribution to mitigating climate change.

Everyone has different ideas on what’s ethical

The problem is that everyone has different ideas about what a climate-responsible portfolio looks like. Some investors accept the reality of the world’s current reliance on fossil fuels and are content to invest in companies that are making good progress in the direction of less GHG-intensity, even if they are not totally pure on this score.

Others have stronger convictions about the need to urgently mitigate climate change and investing in any fossil fuel related company is inconsistent with their ethical stance on climate change.

Unfortunately, off-the-shelf solutions such as managed funds and ETFs can come up short for many investors because they either have too much or too little exposure to high-carbon companies. This is the case even if funds use ESG screening. There will likely be some move towards greater choice of ESG and ethical funds, but there will be limits to how many ESG and ethical fund options can be sustained.

For some, a portfolio of individual shares that is consistent with a person’s personal ethical preferences may be a better investment solution than a fund taking a cookie-cutter approach aimed at the average investor.

Ethical investment trade-offs

An uncomfortable truth about ethical investment portfolios is that they are quite narrowly focused in terms of the types of activities and industries they are exposed to. It’s easy to find climate-friendly investments in renewable electricity generation or services industries. It’s harder to find suitable low GHG-emitting companies in the primary, manufacturing and transportation sectors.

Portfolios skewed towards low GHG emitters will be riskier and have the potential to deliver worse investment outcomes than more diverse portfolios. For some this will be a price worth paying to be consistent with their principles. Others would rather have greater diversification as they work towards their investment goals. For these types of investors, a more balanced GHG-aware, rather than GHG-averse, portfolio will be more suitable.

Balancing ethical views with need to achieve good investment returns

Climate change and the transition to a low carbon future is causing major economic changes. This presents considerable challenges for businesses and investors. In this environment, investors need to balance the obvious moral need to invest in the climate’s interests with the need to get a competitive return on their hard-earned savings.

However, there is no one-size-fits-all in ethical investing. The good news is that with trusted investment partners and quality advice, investors can personally achieve an acceptable balance of both objectives.

John Carran is Jarden’s Vice President, Investment Strategist and Economist. He draws on his deep understanding of economics and leading-edge investment strategies to develop practical investment ideas for client portfolios. John has over 30 years’ experience as an economist and investment strategist. He was previously a Portfolio Strategist and Senior Economist with Kiwi Wealth, an Economist with Infometrics, and an Analyst and Manager with the New Zealand Treasury.  John regularly comments on economic and financial matters.

This article reflects the opinions and views at the time of publication, and is not to be relied upon as a basis for making any investment decision. Please seek specific investment advice before making any investment decision. Jarden is an NZX Firm, a broker disclosure statement is available free of charge at www.jarden.co.nz. Jarden is not a registered bank in New Zealand.

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