Climate Change 2011 Part 1 - Investing in climate change

More broadly, we will analyse the integration of ESG factors into the investment process, as well as the opportunities and challenges in distributing responsible investment products in the wealth management space. When we talk about responsible investing, climate change is surely what comes first to mind, as it is very close to everybody’s heart, probably because it affects everybody’s lives. Climate change has a powerful impact on the global economy, which needs to increasingly move to a low carbon economy in order to meet the long-term policy goals to cap greenhouse gas emissions. Carlos, can you outline how tackling climate change is affecting your investment decisions?

Carlos Joly

By way of background, to put it in context, I think what the climate change issue does is it brings back nature in a very central way in investment management. It is interesting how throughout history, nature was really very integral to how one did business and how one made investment decisions: think of shipping and think of agriculture. Think of storms at sea, floods, storms, droughts and freezings. With the progress of the industrial revolution, and particularly with the emergence of modern portfolio techniques in the latter part of the 20th century, it is as if nature did not matter and there was a redefinition of risk. Real risks got supplanted by technical risks. That is changing and it needs to end. We have to begin to seriously consider how nature interacts with how we make investment decisions, and climate is the most evident way. Now, there are various approaches to doing that, and I think they are represented around this table: everything from private equity to quant approaches that try not to depart from the indices. I think the latter is completely mistaken; if one wants to really invest with a view to what is happening with climate, you cannot follow the indices and you cannot be close to what the general markets are doing. Because what the markets are doing is a reflection of past behaviour. It is like driving a car, while looking out of the rear-view mirror and steering by the dots receding in the background. You are bound to crash. So, from our point of view, what makes sense is to have a non-indexed, high conviction approach, focused on those companies that provide solutions to climate problems, either through mitigation of carbon emissions or adaptation to the inevitable impacts of climate change. Forget about tracking error, have high conviction in your equities selection based on a combination of thematic and financial analysis; and also invest directly in project finance and in projects that are good revenue generators. The investors we are talking about here, the private banking clientele, are interested in protection of patrimony. They take a generational view of the protection of assets, and climate is central to that purpose.

Elisa Trovato

Is the approach of best in class still valid, or do you tend to select the sectors that are most impacted by climate change?

Carlos Joly

We have decided to take a thematic approach, and the thematic approach is driven by a definition of which themes are relevant from the intersection of climate with what is happening in society. Broadly speaking, we have decided that there are three major thematic clusters. The first is, of course, mitigation of carbon emissions; the second is adaptation to the inevitable consequences of climate change; and the third is better management of natural resources: soil and water. Mitigation includes everything related to efficiency: electricity efficiency, efficiency in buildings, efficiency in transportation, modernisation of power plants and transmission lines, and so forth. And, of course, alternative energy falls into that, although curiously, in our fund we have no more than 2 per cent exposure to wind and solar companies. Solar and wind are the immediate knee-jerk reactions to going green, but there are too few listed names and they are too dependent on the vagaries of subsidies in this area. But when you look at the anti-recessionary stimulus programs put into place in China, the US, Brazil and so forth, a great part of that has to do with energy efficiency and modernisation of infrastructure that coincides with what needs to be done from a climate adaptation and emissions reduction point of view.

Now, what does best in class have to do with this? It is helpful, but only in a limited number of sectors. In sub sectors that are heavy emitters, like steel makers and cement makers, one can make intra-sector comparisons to find the companies that have less carbon emissions per ton of steel or cement produced. Think of Australia. How are they going to rebuild their flooded infrastructure and towns without cement and steel, and of the enormous need for reconstruction services? Climate change means extreme weather events with increasing frequency and of increasing severity. So in a few sectors that are very high emitting sectors, one can apply a best in class approach as to carbon. But we are interested is concentrating on the climatic aspects and the environmental aspects, and not in getting sidetracked into considerations of the whole plethora of social criteria that gets applied in best in class SRI analyses. The thrust of our global Impact Fund—Climate Change is to identify those companies whose products are in themselves contributors to solutions—like energy efficient light-bulbs, or water metering systems, or producers of organic compost, or lightweight metals, mass transit equipment makers, freight railways, natural gas producers and transporters, and so forth. It is a focused approach that pays with good investment performance.

Elisa Trovato

At BNP Paribas Clean Energy Partners you have a different approach, as you mainly focus on the clean energy sectors. Do you believe the attractiveness of clean energy is directly correlated to the rise in oil price? Do you expect interest in your funds will increase, because of the surge in oil price related to the Arab world’s turmoil?

Joost Bergsma

I think there is an indirect correlation, in the sense that clearly, the higher oil classic fuels versus alternative fuels is, the smaller the gap is, the easier it will become for renewable energy to be self sustaining. But renewable energy does offer a floor price underpinned, I suppose, by these legislations that are coming out of UNEP, Kyoto, and in Europe, the EU 20-20-20 directive . This directive sets a goal of having 20 per cent renewable energy by 2020. That is a hard law, which provides an important background for us and for our investors to make clean energy tremendously attractive. So, the impact of climate change on investment decisions is probably bigger than one thinks. I agree with Carlos that you have to focus on leaders and you have to pick themes, but at the same time, it is an evolution that has been ongoing and is accelerating. That impacts on more or less all sectors starting with the highest polluters, which is the energy sector, but right now you see it also going into transport and you will see it going into chemicals and into steel. These are major sectors across our index, and all of those sectors are in some way impacted by climate change. You have leaders who are leading the pack and at points will be ahead of the pack, but even the followers will have to clean up their act. I think the energy sector is interesting and at the forefront because of this 20-20-20 paradigm, and we view that the alternative side – the unlisted side – is attractive.

I do feel that climate change is a key driver of clean energy, but a very important other key driver is energy security. It is an absolutely major reason why Germany and Europe, in particular, is actually investing in clean energy. In these uncertain times with oil - but not just oil; also uranium coming from relatively politically unstable markets - energy security is a key reason.

Andreas Knoerzer

I would say there are two angles to the impact of climate change. The first one, on which we all agree, is that it will lead us away from a benchmark and more towards thematic driven investment approaches. One selects adaptation and mitigation, others have different terms; and at the end you have similar investments. The second angle is that there are new opportunities. There is a threat that there are traditional companies and industries who are victims of it and it would not be bad to screen your classical, standard investments against climate change criteria, to see whether they are victims to a greater or lesser degree. That is important input to enable a good investment decision. We do offer access to thematic approaches, either using funds in our portfolios or direct holdings which are part of the thematic investment universe. But we also use products which are a bit closer to the blue-chip world. Both have value.