Three Key Climate Change Investment Themes

By Taimur Hyat — Mar 8, 2021

5 mins

The intense winter storms that plunged Texas into a deadly energy crisis are a stark example of the sweeping impacts of climate change on infrastructure, communities, and people.

The Biden administration’s recommitment to the Paris Agreement and ambitious climate agenda should usher the US back into the global effort to combat the climate crisis. But government and regulatory action, while essential, will not be enough.

If we are to mitigate the most devastating effects of climate change, it is vital that the global private sector plays its part. This will require investors not only to protect against the downside risks from a changing climate but also to embrace the breadth of opportunities available from supporting the transition to a greener planet.

In a major study of more than 100 large global institutional chief investment officers, each managing more than $US3 billion, we found 42 per cent are not incorporating climate change considerations into investment processes. This number rises to 46 per cent in Asia and 53 per cent in the US, while in Europe 81 per cent of investors are incorporating climate into their investments.

More worryingly, 40 per cent of those surveyed believe climate change is “not significant” in asset allocation decisions. To reverse these mindsets, it is imperative investors build an opportunity-driven agenda for tackling climate change centred around three key investment themes.

Opportunities include overlooked parts of the world, winners in carbon-intensive industries and a new lease of life for venture and early-stage capital.
Taimur HyatChief Operating OfficerPGIM

First, the most attractive climate-combating opportunities are in overlooked corners of the market. For example, wind and solar projects in emerging markets such as Chile and Uruguay (with ageing hydro-electric networks and declining river flows) are ripe for investors willing to look beyond saturated markets in the US, Europe and, to a growing extent, Australia.

Further, peripheral investments several degrees removed from direct renewable investing may represent untapped opportunities. For example, upgraded transmission networks to bring large-scale solar and wind power generation facilities to urban centres with minimal leakage, or smart grids that can toggle between intermittent renewable sources and steadier traditional energy sources.

Second, increasingly rich data allows discerning investors to differentiate between winners and losers in carbon-intensive industries with growing precision. This ability to parse the energy sector is critical because even under the most aggressive assumptions of renewable adoption, fossil fuels will have a long sunset, driving nearly two-thirds of global energy use until at least 2050.

Given this unpleasant arithmetic of energy supply and demand, some investors may want to engage with – and positively influence the direction of – the greenest firms within brown fossil fuel industries. Australia’s biggest greenhouse emitter, AGL, recently wrote down $US2.7 billion in assets – or more than two-thirds of total shareholder equity – demonstrating that vehement opposition to government reforms and reliance on coal-powered energy placed it at significant obsolescence risk. Conversely, German energy company RWE is the second-largest offshore wind developer in the world and while many investors still view RWE as “dirty” because of its legacy coal business, it has struck a deal with government to transition out of coal completely.

Indeed, improvements in company-level carbon and climate data allow investors to identify winning firms in the traditional energy sector that are leaning heavily into greener technologies while steering clear of fossil fuel dinosaurs with high obsolescence risk. This more nuanced perspective allows investors to move beyond binary divisions of “green” renewable heroes and “brown” fossil fuel villains.

Third, green investing may provide a new lease of life for venture and early-stage capital – an investment area that has generated close to net zero alpha since 2000 and faces a shrinking opportunity set given the defensive moats the technology giants have built around their businesses. One set of opportunities exists in potentially transformative early-stage technologies such as hydrogen-powered cells or carbon capture and storage. Another exists around “ag tech” as precision agriculture technologies are used for real-time farm monitoring, advanced weather forecasting and vertical farming. In parallel, the greening of capital markets creates nascent investment opportunities in financial instruments such as green bonds, carbon emission allowances, resiliency bonds and solar asset backed securities.

Re-setting the climate agenda could unleash a multitude of untapped opportunities for investors looking to combat climate change. For the majority of institutional investors who acknowledge climate is a long-term consideration but are yet to incorporate it into their portfolio, the time for contemplation has passed. Now is the time for investors to look beyond climate primarily as a risk factor and seize the emerging opportunities to speed the transition to a greener planet.

Article originally appeared in the Australian Financial Review

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