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Climate Change will be reflected in your portfolio in 2018 and beyond

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2018-03-13

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Most countries have signed the Paris Agreement to limit global warming to less than two degrees Celsius (2C) above pre-industrial levels - the threshold where many scientists see irreversible damage and extreme weather effects kicking in. The signatories have submitted plans to reduce carbon emissions in so-called intended nationally determined contributions (INDCs). Yet some scientists say these commitments alone are not enough to keep temperature rises below 2C.   

Whilst I believe we have (as humans) been slow to prepare for the climate change I am encouraged that we are now on the right track to making progress and this is occurring despite the largest economy in the world withdrawing (the U.S.) from the Paris climate agreement, the sole nation to do so. 

Global warming is the term used to describe the current increase in the Earth's average temperature. Climate change refers not only to global changes in temperature but also to changes in wind, precipitation, the length of seasons as well as the strength and frequency of extreme weather events like droughts and floods.  Global warming causes climate change, so the 2 terms are very much related.

Climate change risks have the potential to quickly and significantly affect the value of investments and, therefore, represent both material financial risks (and opportunities). Globally there is a push to consider climate risk from the heads of regulators as they acknowledge the flow on the effects to financial stability.  Bank of England governor Mark Carney has recently warned investors that they face huge losses from climate change because reserves of oil, coal and gas could become literally "unburn able". 


Source Reuters

The implications of investors reducing their allocation of capital to fossil fuel companies must be ringing alarm bells as the risk of stranded assets looms.  

Stranded Assets -  The term "stranded assets" has become synonymous with asset owners divesting their holdings in fossil fuel-related companies. An asset is stranded when it is no longer usable (submerged real estate) or the cost to use or extract it exceeds its revenue potential.

These issues cannot be ignored by trustees and their directors as part of the investment governance of their funds, notwithstanding their personal, moral or ideological views on the reality of climate change.  For those that don't consider RI ESG as a key theme for investing please consider this:

section 52 of the Superannuation Industry (Supervision) Act 1993.

A key requirement contained in the act is that trustees perform their duties and exercise their power in the best interests of beneficiaries.   s52, doesn't say anything to the effect of "best financial interest" and it is really saying that you need to be operating in beneficially best interest, as opposed to self-interest.  The best interest will consider all potential risks.

Geoff Summerhaynes, a member of APRA has appropriately reminded directors who fail to properly consider and disclose foreseeable climate-related risk that they could be held personally liable for breaching their statutory duty of due care and diligence under the Corporations Act.  A key message from Summerhaynes is that climate risks are not a potential problem or non-financial risk but  "foreseeable, material and actionable".  

Climate change should be grasped as an opportunity to truly put your wealth to work in attractive investment opportunities as the world moves to a low-carbon economy.  The Australian Council of Superannuation Investors (ACSI) recently released Governance Guidelines providing insights for the first time on how large investors expect climate change issues to be managed.  The Guidelines, updated every two years outline its members expectations of the governance practices of the companies they invest in. This year, a new chapter on environmental, social and governance (ESG) issues has been added.

ACSI says the Paris Agreement, signed in late 2015, has resulted in a global focus on reducing the emissions intensity of economic activity to stabilise global warming to less than 2C and on moving towards a net zero emissions economy by the second half of the century.

When it comes to climate change, ACSI expects to understand whether a company can:

  • successfully identify and manage the climate change risks and opportunities it faces
  • demonstrate future viability and resilience by testing business strategies against a range of plausible but divergent climate futures, including a 2C scenario
  • achieve cost savings through efficiencies and identify low carbon opportunities.

Where companies identify climate change risks as material, ACSI says disclosures should extend to discussing the strategy, as well as metrics and targets, used to manage the risk.  Glennon Capital expects companies materially exposed to climate change risk to make substantive improvements in their climate-related reporting. We also suggest that this will flow through to reporting requirement of Institutional Investment Mandates and Superannuation reporting.  Climate Change is a risk and an opportunity.

Glennon Capital believes that resource constraints and environmental challenges like climate change, pollution and water scarcity necessitate significant change. This requirement for change should be both at the domestic household level and to business practices.  These inevitable changes present significant investment opportunities and risks over the coming decades. Consequently, our research is directed towards developing a deep understanding of companies and industry dynamics, which in conjunction with robust valuation frameworks enables us to identify stocks that offer attractive return potential.

We believe it is our responsibility to encourage companies to maximise investment returns through good "ESG" practices, including respect for society and the environment.

As shareholder's in many companies, we are well-placed to actively promote best-practice in environmental, social and governance matters. Evidence suggests that companies which rank among the leaders in sustainability tend to outperform over the long term.

There is no doubt that 2018 will be a busy year for climate action. If your fund manager is investing in companies that have a board that does not consider the climate change risks, then they are not doing their job. 

Tarren Summers is the Co Portfolio Manager of the GC RI Future Leaders Fund

He has over 20 year's experience working in equities markets and boutique Fund Managers.  Tarren is responsible for implementing, and contributing to the determination of, the business's operational and strategic objectives and distribution of the investment capabilities. An important part of Tarren's role is to ensure that the investment team have all the resources required to perform their function without distraction, while also ensuring that investors are well informed about their investments.

Tarren began his career at Mercantile Mutual in Client Service's before moving to London and working in transition management for Merrill Lynch. Recent roles include working at PM Capital Ltd (Paul Moore) for over eight years as the Portfolio Analyst with responsibility for ESG analysis and investment analytics.  Tarren worked with Investors Mutual (Anton Tagliaferro) where he was the Senior Analyst responsible for research data and communication.  He joined Paradice Investment Management (David Paradice) as the Head of Client Services. He holds Bachelor of Science from the University of New England, Graduate Diploma Applied Investment Management and a Diploma of Financial Planning. 

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Name Tarren Summers Chief Operating Officer, Glennon Capital