If Kermit had an investment portfolio today he’d probably be singing a different tune, because nowadays it’s becoming a lot easier being green — and potentially a lot more lucrative.
The decision to steer clear of fossil fuel investments, for example, is a choice that can increasingly be made by investors based more on hard-nosed investment risk and return assessment than ethical considerations. Many investors, both personal and institutional, are concluding that investments in high emission intensive companies, for example thermal coal, are looking just too risky. And this is being backed up by hard facts — examples include the share price for resources company Santos, down 44% over the year to July 1, 2015. Over the same period, Glencore was down 24%, and Rio Tinto down 18%.
The sharemarket continues to be favoured by SMSF trustees, with the latest Multiport SMSF Investment Patterns Survey (up to March 2015) confirming the continuing love affair that trustees have with Australian shares. Local equities made up the biggest slice of SMSF investment portfolios at 38.6%, followed by property (17%), cash (16.5%), international shares (14.4%) and fixed interest (13.1%). The fact that SMSF investment portfolios are generally 53% invested in equities, either directly or through managed funds, suggests the sharemarket is not budging from centrestage of SMSF investment strategies any time soon.
The returns made on investments are of course centrally important to any investor, be they individuals, institutions or SMSFs. In this regard, the Responsible Investment Association Australasia reports in its 2014 Benchmark Report that “core responsible investment” funds under management in Australia and New Zealand increased by 13%, and that “responsible” equities funds outperformed the ASX300 index and the large cap Australian equities fund average over the past one, three, five and 10 years.
It’s hardly surprising that investors take notice when the globe’s most successful investor Warren Buffett offers an opinion on the sharemarket, especially when he backs up that opinion by making adjustments to his portfolio. In a similar vein, SMSF trustees concerned about their fund’s investments, and protecting their own hard-won assets, could do well to heed the global movers-and-shakers.
The third annual Asset Owners Disclosure Project (AODP), an independent not-for-profit global organisation with an objective to protect retirement savings and other long term investments, has pronounced climate change as one of the biggest global factors that will influence investment performance over the long term.
The AODP index is sourced from the data of the world’s largest 500 asset owners, including pension funds, sovereign wealth funds, insurance companies, foundations and endowments. Funds are rated AAA through to D, with an extra X category for the real laggards (read the entire document here). The AODP says its methodology is purely performance focused, and asset owners do not get points for commitments or public relations statements.
AODP chair and former Liberal party leader John Hewson says the risk of climate change seems to be severely underestimated by many global banks and pension funds. “It’s a significant risk and it dwarfs the risk that was taken in the context of the sub-prime,” Hewson said when launching the latest index (referring to the sub-prime crisis that many blame as the last straw for the GFC of 2007-08). “The risk of a climate-induced global financial crisis is very real,” he said, “and is getting more real every day if these sorts of activities continue.”
SMSF investments: The way forward
The fact that should be piquing the interest of SMSF trustees when assessing investment and climate change risk is that these views are being taken seriously by the heavy hitters in the financial world. AODP’s findings echo those from a recent study by Mercer, which has found that investors cannot ignore the implications of climate change on investment returns.
Mercer’s research found that investors can manage the risks imposed by climate change most effectively by looking “under the hood” of their portfolios and factoring climate change into their risk modelling — which Mercer admits may require “a significant behavioural shift” for many.
The report, titled “Investing in a time of climate change”, outlines actions for investors to not only manage key downside risks but also to access opportunities.
The investment modelling in Mercer’s report estimates the potential impact of climate change on returns for portfolios, asset classes and industry sectors between 2015 and 2050. The outcomes are based on different climate change scenarios, representing a rise in global temperature above pre-industrial era temperatures of 2°C, 3°C and two 4°C scenarios (with different levels of potential physical impacts).
The investment modelling supports the following key findings:
Climate change will give rise to investment winners and losers: Based on the scenarios modelled, climate change is expected to have an impact on investment returns; investors need to take action to understand and mitigate the risks and maximise value at the asset, industry sector and portfolio level.The biggest risk is at the industry level: Differentiation between winners and losers is most apparent at the industry level. For example, depending on the climate scenario which plays out, Mercer says the average annual returns from the coal sub-sector could fall by anywhere between 18% and 74% over the next 35 years, with effects being more pronounced over the coming decade (eroding between 26% and 138% of average annual returns over the next 10 years). Conversely, the renewables sub-sector could see average annual returns increase by between 6% and 54% over a 35 year time horizon (or between 4% and 97% over a 10-year period) depending on the climate scenario.Asset-class return impacts will be material, but vary widely: Growth assets are more sensitive to climate risks than defensive assets.
Another factor that AODP’s Hewson says should be front-of-mind for investors is that most governments around the globe are not likely to regulate markets effectively away from such climate risks. “Asset owners hoping that policymakers bail them out of their climate risks need a reality check,” he says, adding that AODP realises that the index’s leading funds “have a duty to mitigate portfolio risk against continuing political intransigence.”
But the leading funds know about the looming “sub-clime” risk (as AODP labels it, tongue-in-cheek). Hewson says that they are thus “increasingly underweight carbon to the extent that if every fund copied their approach, we would be well on the way to solving climate change”.
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