| We cannot ignore the environment |
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| Written by Alan Brown, chief investment officer, Schroder Investment Management | ||||||||
| Tuesday, 21 August 2007 | ||||||||
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Climate change will be one of the biggest investment themes of the next 20 years With parts of Britain under water and forest fires in southern Europe this summer as well as the worst of the annual hurricane season yet to hit the Caribbean and southern US, it is hard to get away from news of climate change and how it is affecting daily life. Without wanting to praise those who led the argument that climate change is the most serious issue facing the human race, it also represents one of the biggest investment themes for the next 20 years. As such, it is time investors understood how and why climate change and investing are related and how they can adjust their portfolios accordingly. This is not just about socially responsible investing or even whether you believe the scientific evidence. As an asset manager we have a fiduciary responsibility to provide investors with the best risk-adjusted returns looking at market trends and emerging sectors. It is becoming apparent that our responsibility extends to include environmental considerations in this analysis. To many in the industry this seems counter-intuitive, particularly alongside the conventional wisdom that sensitivity to environmental factors detracts from investment returns. The oft-stated reasons behind this thinking being that either environmental rankings in stock selection are negatively correlated with the price performance of stocks, or the environmental screening resulting from SRI diminishes the opportunity set of companies that an investor can buy. Dispelling these myths is a range of investment analysis forming the foundation of why investors should pay attention to how climate change affects them. The reason is simple: companies that are aware of climate change are more likely to respond quickly and effectively to changes in the market, identifying and capturing upside opportunities for additional profit and competitive advantage. This understanding that a management’s awareness of the external factors affecting a business can enhance returns sits well with investors looking for companies taking the long view, anticipating changes and including these in their business plans. From this it follows that the link between climate change investing need not bear any relation to the traditional idea of SRI. Taking a different approach, it has been claimed that investors who consider environmental aspects in their stock selection are limiting the potential of their portfolio returns as they are effectively self limiting the pool of companies in which they can invest. This too is understood to be a fallacy. There is little evidence that capping a portfolio of stocks by environmental criteria has any more impact than setting one by region or market capitalisation. This idea is further undone when you realise that more companies are not only taking note of changes in the environment but also acting on them. The underlying theme here is that climate change is a powerful enough force that there will be companies that will be positively and negatively impacted as mankind attempts to mitigate and adapt to climate change. Even if you choose to ignore the scientific evidence of climate change, it is apparent that consumers and legislatures are responding to environmental changes. The reality is that climate change is driving a massive industrial transformation. As such, surely one of the best things investors can do is invest in those companies that are part of the transformation? Leading these would be the companies at the cutting edge of new technologies, such as solar power and natural gas technologies. But change will not be limited to new companies and technologies. Established companies that successfully navigate the transformation will most likely outperform the market over time and generate strong returns. It would be hard to ignore the rapid growth of the hybrid market for cars in recent years – last year, the market grew 30%. Asset managers and investors only have to look to which stocks are doing well within this trend and consider how they are placed in a portfolio accordingly. Toyota is a good example; the group improved its market share for hybrids from 72.6% to 82.8% last year. At the same time, it sold 275,000 units, representing 3.5% of the group’s worldwide production. As it is anticipated that sales will continue to grow with the market, this is an area to watch. And look at AGCO, one of the world’s largest manufacturers of agricultural equipment. As society starts to look to use less carbon-intensive fuels, governments are turning to bio-fuels including bio-ethanol and bio-diesel to run their vehicles. To produce these substitute fuels requires agricultural feed stocks such as corn or sugar and, as a result of demand from the bio-fuel industry, prices for many of these agricultural commodities have been rising. This is driving increased demand for agricultural equipment. Most likely this will support demand for AGCO’s products for years to come. While not obviously a company benefiting from climate change directly, its business is being favourably affected by shifts in demand prompted by climate change. Whatever your personal take on climate change, it is clear we have reached a tipping point in public and political opinion. This is fuelling a change in consumer and investment trends, which will not only continue but accelerate in the years to come. Investors need to understand how the companies in which they place their money are rising to the challenge. As professional investors we face increasing governance requirements to understand how the companies we are investing in are performing, and not only in financial terms. One way or another, this has all the makings of being the biggest investment theme of the next 20 years.  Quote this article on your site | Views: 1145
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