Climate Action - investors have a part to play

Posted by Liz Rees in Latest insights category on 20 Dec 19


Global stock markets enjoyed a belated Santa rally after the US and China called a halt to their lingering trade spat. At the same time, British investors welcomed the election of a business-friendly Conservative government. Most geopolitical concerns are short-term but one that is set to remain firmly in the spotlight is global warming.

Where we stand today

There has been widespread media coverage of environmental issues this year and interest in sustainable investing is growing. A series of events concluded with leaders from over 100 countries attending the United Nations (UN) conference on climate change (COP25) in Madrid this month.

Unfortunately, the UN conference failed to formulate a framework for a new global carbon trading market, hampered by China and India wanting to transfer carbon credits held under the 1997 Kyoto protocol agreement.

Since the 2015 Paris Agreement set targets to limit global warming to 1.5-2.0˚C above pre-industrial levels, progress has been slow. While fossil fuels remain essential to the global economy, many governments concur that a charge should be imposed on carbon usage to channel consumption towards lower carbon alternatives.

The UK, Norway and the European Commission (EC) have zero targets by 2050 but none have clear policies to achieve this. Meanwhile, President Trump has withdrawn the US from the Paris Agreement whilst China and Japan continue to build coal-fired power stations. Much of the developing world is still reliant on thermal coal.

Nevertheless, the conclusion from COP25 was clear; without action, we face the risk of irreversible damage to the planet. As well as the human cost, the financial costs are significant.

Big names back action

Mark Carney, Governor of the Bank of England, is to take on the role of UN Special Envoy for Climate Action and Finance whilst incoming ECB President Christine Lagarde has warned that climate change is the most pressing global challenge. At COP25 Al Gore, former US vice president, advocated total divestment of fossil fuel shares, due to the economic risks posed.

The Chief Executive of Goldman Sachs, David Solomon, believes there is a strong business and investment case to tackle climate change. His company will commit $750bn, over ten years, to climate transition opportunities, including clean energy, transport and sustainable food.

Analysing investment risks

The oil and gas sector is a large part of the investment universe, particularly in the UK, and this raises difficult questions for investors. Capital expenditure in the sector has declined substantially as focus switches to renewables.

As a result, for every six barrels of oil consumed, only one is replaced which could create a supply shortage over the next decade. If this drives the oil price higher, it would actually boost profitability, and potentially the share prices, of oil companies.

Oil majors are highly cash-generative, not reliant on external funding, so investors should look at where they are reinvesting their cash flow. If it is into renewables they may capitalise on the energy transition provided they are not left with a portfolio of uneconomic oil assets.

Government policies may accelerate the transition. One of the most negative policies for energy companies would be carbon taxes. These provide an incentive to redirect investment toward low-carbon technologies. Other polluting industries could also be affected by such policies.

Carbon taxes do bring environmental benefits, such as reduced air pollution, and can raise additional revenue for governments.

The carrot or stick approach?

At present most policies are voluntary. The Principles for Responsible Investment (PRI) organisation supports an international network of investors in incorporating Environmental, Social and Governance (ESG) factors into their investment and ownership decisions.

Climate Action 100+ is a global network of over 370 leading investors, which aims to force the biggest greenhouse gas emitters to take action on global warming. Royal Dutch Shell, BP and Glencore have all responded, with Shell agreeing to halve its carbon footprint by 2050.

Ultimately, fund managers take into account their investment objectives, such as income generation, backed by fundamental analysis to decide whether to include fossil fuel companies in their portfolio. However, increasing numbers are excluding them through self-imposed ethical or sustainability screens.

Others permanently divest as a point of principle and we are seeing a lot of large pension funds coming under pressure from both trustees and members (especially in the public sector) to take this approach. Another group of investors prefer to engage with companies to encourage them to improve their practices.

A new era for funds

We expect interest in sustainable investing to continue to grow. However, when considering funds remember to ensure they are suitable for your long-term goals. To assist you, we show sustainability (or globe) ratings for funds on the Willis Owen website. These reflect the ESG risk ratings of companies held in portfolios.

Morningstar bronze-rated Royal London Sustainable Leaders fund invests in UK listed companies that have a positive effect on the environment, human welfare and quality of life.

Simon Edelsten, the manager of silver-rated Artemis Global Select fund, believes that a sustainable investing approach can reduce risk and enhance returns. He avoids oil producers and favours businesses like wind farms.

Finally, Fundsmith Sustainable Equity fund avoids a number of sectors including: aerospace and defence, oil and gas, tobacco and metals and mining.

Important Information: We do not give investment advice so you will need to decide if an investment is suitable for you. If you are unsure whether to invest, you should contact a financial adviser.