The Bigger Picture: Sustainability big themes (Part 1 Sustainability investing is not just ESG)
"Climate transitions are a $100 trillion investment opportunity" Forbes 2021
Its not just about renewables - think grid resilience and energy security.
While wind and solar are going to be the big investment opportunity in terms of $ spent over the next two to three decades, the really interesting opportunities are going to be in modernising the electricity grid, so that all of this new variable generation can be accommodated and used by consumers.
Better informed asset owners can make better sustainable investing decisions
Simple fact - better informed asset owners and investors can make better and more meaningful climate related investment decisions. And being informed has never been more important. If your objective is to help deliver the required climate related transitions, while still earnings a fair financial return, you will be very aware that there are lots of trade-offs and compromises, lots of potential dead ends and stranded assets, and lots of green wishing and green washing. Plus, there is no simple algorithm or silver bullet. It doesn't matter if you invest directly, or if you use advisors, the better you understand how the climate related transitions could play out, the better placed you are to make your investing decisions.
As this is the first of the Bigger Picture blogs, we start with the very big picture.
If you want to skip the introduction and go straight to the theme click here. These are, by necessity, longer blogs. The complexity of the climate transitions means we can only simplify to an extent, there are lots of interconnected moving parts. While we would love to say that this blog gives you all the answers, even in this extended length format we can only really flag the things you need to think about, and the questions you need to ask. But then in a world where everyone seems to be trying to sell you an easy solution, we think that is a really good start.
Three reasons for investors to think about sustainability and ESG
Lets start right at the very beginning. There are broadly three reasons why asset owners invest in sustainability and ESG. These are not mutually exclusive - real world investors might be motivated by a combination of all three. However, its useful to separate them out, as they imply very different priorities and approaches when we come to construct investment portfolios.
They want their portfolios to be aligned with their values. The most common form of this is to use the ESG scores of the portfolio and the companies in it, and the policies that their asset managers use to select investments, as a proxy. This approach may also include active engagement to drive change. Aligning values with holdings is actually harder than it sounds, with many ESG rating systems being more focused on the impact on the company, rather than the impact the company has on the planet.
They see ESG as an additional risk measure. By including this in the investment case for a company, they can avoid future value destruction (stranded assets, flooding risk etc) and, in some cases, identify ESG factors that can lead to improved long term value creation (such as board diversity). This is arguably the main reason why most asset managers use ESG data.
They see a material investment opportunity. The climate related transitions (including those wider changes that will be needed to create a fairer and more stable society) will require the deployment of vast amounts of capital. Intelligently allocated investments in these activities could not only generate a fair long term financial return, but they could also reduce the risk of a disorderly climate related transition.
The massive investment opportunity
The analysis in this blog is largely focused on the third reason, the investment opportunity. There is also a nod to the second reason, with future blogs on this theme picking up on the risk of future value destruction. We also intend to expand on our view that a disorderly climate related transition over the coming decades is perhaps the biggest risk asset owners face in relation to future financial returns (plus of course to the survival of our planet - at least in its current form). Other blogs, principally in our Thinking Differently series, will pick up on the potential for ESG related factors to be a good indicator of future "unexpected" value creation.
Five big climate transition related investment opportunities
From an investment perspective, there are broadly five themes which dominate greenhouse gas (GHG) emissions and climate related mitigation and adaption. These are multi decade investment themes that will shape our society and determine the likely level of our future financial returns.
Distributed energy/renewables - where our energy comes from
Agriculture/natural capital/food - what we eat & where it comes from
Our built environment - our buildings and cities
Materials/supply chains plus circular economy and reuse
Transport - including shipping, aviation and freight
Fixing these challenges gets us most of the way there
If we can "fix" these five challenges, we reduce the majority of the risk we face around the climate transition impacts. On the flip side a very disorderly climate related transition could materially impact not just our planet, but also the level of our future financial returns. And its these returns that will fund our retirement, pay for our children's education, and support essential services like hospitals and the care of the elderly. Not all of the required changes can, or will, occur quickly. These are multi decade themes. In terms of solutions. some (such as EV's and renewables) are happening now. Others, such as electricity grid enhancement, are approaching scale, while a few, such as industrial carbon capture or green hydrogen, could potentially take decades to roll out.
Why might you care ?
We assume you care about mitigating the climate transition impacts, while at the same time wanting to earn a fair financial return. This could be because you want a better alignment of your investments with your values, one that goes beyond a simple ESG score, and that is better matched to the needs of the climate change transitions. It could be that you want an exposure to the massive, multi decade investment opportunity that building the new systems we will need is creating. Or it could be that you have a real concern that a disorderly climate transition could materially damage your long term financial returns. If none of these apply, you should probably stop reading now.
So you care - what do you do next.
There is a vast amount of published material on the climate change transitions. So why might you want to read yet another blog ? First, so much of what gets published isn't actually that useful for investing - by that we mean the processes around identifying where your capital gets allocated AND how you might use the leverage your investments create to better engage with companies, governments and wider society. These blogs build on my many years experience in the investing world, so hopefully bringing a more practical perspective. Second, we are not selling you something. We don't promote individual companies or investment funds. We want you to be better informed, full stop. In our industry this is rare.
The Bigger Picture blog series aims to give you some of the important tools and understandings you will need to make better climate transition related investment decisions. As we highlighted above, these blogs are primarily about investments that will make a real difference, principally by replacing existing environmentally and socially damaging activities, but also by avoiding investments in activities that we expect to become value destructive. They will also give you tools to allow smarter and more incisive engagement.
It is important to note that nothing in these blogs should be construed as either investment advice or marketing material (as defined by the FCA and other financial regulators).
We build on the material in these blogs in more depth in our weekly Sustainable Investing blogs. If you want to know more, contact us and we can discuss how we can help.
Where to start.
For each of the five themes we start with the challenge to be resolved, then how big could this market become, over what time period will it grow, and potential barriers to growth. And, because this is about investing, what issues and factors do you need to be aware of and monitor, so trade-offs, risks and compromises. Then the biggest pushbacks we hear from the sceptics, and where they might be right or wrong. Finally, how will the transition impact on industry structure, so competitive advantage, barriers to entry and potential profitability. Basically, the things an asset owner or investor might need to know as they make decisions about where to invest in the climate transitions.
One final but important point - this is not just about technology. Sustainable Investing also includes considering how and why we make investment decisions, human rights, diversity, social and political factors including communication and regulation, and the big topic of engagement. We should never forget that people are at the heart of how the transitions will develop, and people are not always rational.