Sustainable Investment – Why and when are we getting more radical in our asset allocation?

by Gudrun Timm

Science and industry surveys are delivering a persistent message

Global warming has been scientifically explored since the 1960s. Public attention grew with the publication of The Limits to GrowthI warning of an eventual collapse of production and living standards due to resource depletion. The United Nations (UN) has been addressing “Sustainable Development” since the first “earth summit” 1992 in Rio de Janeiro, defining it as “meet(ing) the needs of the present without compromising the ability of future generations to meet their own needs”II . Since then, all ecosystems on our planet remain in decline. Already, environmental and social risks have increased in likelihood as well as impact over time.

Climate Risk – What does it mean for business?

In its current risk map, the World Economic Forum ranks extreme weather events and the failure to mitigate climate risk or adapt to climate change as the top risk for business. The shift is clear: Since 2017, no risks from the “Economic” category have ranked among the top 10, despite increasing volatiliy in financial markets. Environmental and geopolitical risks outrank all economic risks, even cyber risk. What is more: As the risk categories are interconnected, knock-on effects are expected to accelerate, with damages exponentially growingIII.

Climate Risk – How does politics shape the business environment?

During the past two decades, governments, institutions, businesses, and citizens have acknowledged global warming. By 2017, all nations, had signed up to the Paris Accord and committed to keep global temperatures well below 2.0⁰C above pre-industrial times and „endeavour to limit“ them even more, to 1.5⁰C. Each country’s contribution to cutting emissions will be reviewed every five years. Rich countries pledged to help poorer nations by providing „climate finance“ to adapt to climate change and switch to renewable energy.
In October 2018, the Intergovernmental Panel on Climate Change (IPCC) released a wake-up call: A special report highlights the difference between a “slow action”, a 1.5⁰ C, and a 2⁰ C scenario. Key conclusions are:

  • Less than 12 years remain for governments to act and avoid the tipping point where changes become irreversible, and the planet ceases to provide a habitat for mankind.
  • Radical, large-scale policy change is needed, and fast, requiring annual average investments in the energy system of around $2.4 trillion (about 2.5% of global GDP) for two decadesIV.

The UN Emissions Gap Report assesses current policies of each of the G20 members and the gap between the trajectories that governments actually choose and those that are necessary to meet the Nationally Defined Contributions (NDC) in accordance with the Paris AgreementV. To close the gap, the UN report calls for fiscal policy reform to create strong incentives for low-carbon investments and reducing GHG emissions. Creating carbon markets through carbon emission trading regimes, starting with the ETS in the EUVI, and carbon taxes are the most common instruments.
Countering those efforts, in many countries fossil fuels are still subsidized to enhance industrialization and GDP growthVII. Fossil fuel subsidies stand at 6.5 % of global GDP, according to recent IMF estimatesVIII. The United States of America are formally withdrawing from the Paris Agreement, and will leave by 2020.

Increasing the sense of urgency – the “Greta” momentum

While governments have acted slowly, market changes seem to be accelerating through a shift in consumer behaviour and societal pressure.

The “Fridays for Future” kids feel that governments have not acted rigorously enough in responding to warning signals. They take to the streets to campaign for adapting to climate change at a pace that will leave the planet habitable for the 10 billion inhabitants expected in the next generation.

Municipalities, at the lowest administrative level, are quickest to respond to societal concerns and acknowledge: Sustainability is for everyone. To date, 1,180 jurisdictions in 18 countries have declared a climate emergency. They include 290 million citizens. Among them are London, Paris and CologneIX.
Most assets are currently invested in “old” industries and in developed capital markets. Clearly, restructuring the economy will encompass decarbonising efforts on a global scale and changed consumer behaviour.

For investors, this means that the investment environment may change in a more drastic way than we currently realise. Only a shift in the asset allocation might save and enhance asset values. If political decisions do get more radical once millennials unfold their financial weight as consumers and workers, entire markets may dry up, others evolve. Assets that are at present considered valuable may need to be written off. Alternatives are needed.

Read more next week on how to shift the asset allocation.

  1. The Limits to Growth, Report for the Club of Rome, 1972. Translated into 30 languages, 30 m copies sold.
  2. Following the “Brundtland” Report of the World Commission on Environment and Development, 1987
  3. World Economic Forum: The Global Risks Report 2019
  4. The Intergovernmental Panel on Climate Change, Special Report: Global warming of 1.5°C, October 2018
  5. UN Environment Programme (UNEP): Emissions Gap Report 2018, November 2018
  6. EU Commission: EU Emissions Trading System
  7. International Energy Agency (IEA): World Energy Outlook, 2018
  8. IMF Working Paper: Global Fossil Fuel Subsidies Remain Large, 02.05. 2019
  9. , 4 th November 2019