Decarbonisation: why is it relevant?
Climate-related financial risk is not widely recognised by investors. Plastic pollution, water scarcity, and wealth inequality all carry financial risks; carbon, however, is particularly important because of the magnitude of its impact on climate change, and the risks and opportunities for shareholders, the environment and society are inextricably linked.
Although decarbonisation is gathering pace its risks are not reflected in stock market valuations. Consequently, investors face a continued risk of a dropping share prices.
“What is a “green swan”?
A “black swan” is an event that is unpredictable, improbable and unfamiliar, and carries serious consequences. However, we believe that decarbonisation – a “green swan” climate-related event – is predictable, probable … and we already its happening.
Individual savers are becoming increasingly aware of the potential impact of their investments, and demand for sustainable investment funds continues to accelerate. If the global economy is to address the needs of all the key stakeholders – planet, people and profit – share prices need to better reflect the embedded climate-related financial risk.
Climate risk threatens share prices
Market valuations do not reflect the potential impact of climate risk on businesses and investments. In 2020, for the first time in history, the World Economic Forum found that the top five global economic risks all related to the environment.
It is clear that we can no longer separate the needs of key stakeholders, and the balance between these stakeholders will ultimately determine future economic stability and corporate opportunity.
“In 2020, for the first time in history, the World Economic Forum found that the top five global economic risks all related to the environment”
Preparing for decarbonisation
Climate-related risk analysis is no longer a sign of prudence or virtue – it is now a legal obligation. The inevitable policy responses are likely to happen more quickly than expected, and their effect will quickly be felt by businesses and investments. Governments are beginning to respond and regulation has begun to accelerate.
Many catalysts could trigger mass decarbonisation – for example, a sudden drop in financial markets, geopolitical tension between two nations, or new regulation. If the global economy decarbonises more quickly than anticipated, the financial impact is likely to be sudden and severe.
In general terms, companies that have a higher carbon output than their peers are likely to have higher costs that create a competitive disadvantage. Meanwhile, businesses that decarbonise faster should be in a stronger position than their peers.
Not if, but when
The UN-supported Principles for Responsible Investing (PRI), an organisation that includes around 500 global asset managers, recently released a report warning that the realities of the climate crisis will inevitably catch up with governments across the world.
The PRI also noted that “financial markets today have not adequately priced in the likely near-term policy response to climate change”.
“The question for investors now is not if governments will act, but when they will do so, what policies they will use and where the impact will be felt. The [Inevitable Policy Response] project forecasts a response by 2025 that will be forceful, abrupt, and disorderly because of the delay.” (Principles for Responsible Investing, “What is the Inevitable Policy Response?” 2019)
Measure the problem to manage the impact
Our approach embeds the philosophy of the Task Force on Climate-related Financial Disclosure (TCFD) framework to understanding the materiality of climate-related risks.
The TCFD was set up in 2015 to develop consistent and increased reliable information on climate-related risks. It has created a framework which lays the groundwork to build carbon-pricing mechanisms that will enable the market to quantify the level of direct climate-related risk in financial terms.
“Increasing transparency makes markets more efficient, and economies more stable and resilient.” (Michael R. Bloomberg, Chair of TCFD)
The TCFD outlines four categories of climate-related risks and opportunities:
- Policy and legal risks – constraint of adverse climate impact and promotion of adaption
- Technology risks – improvement or innovation
- Market risk – commodity, product or service risk
- Reputation risk – customer or community perception
Policy acceleration and physical impact
Although the scope of issues is vast, the two crucial areas of which investors need to be aware are policy acceleration and the physical impact of climate change.
- Policy acceleration – socioeconomic governing bodies are beginning to realise that we are not reducing emissions fast enough. The climate crisis is no longer just an issue for future generations to worry about; it is the defining challenge for our world today. An acceleration in policies to mitigate climate change is likely to have a tangible impact on the value of investments.
- Physical impact of climate change – extreme weather events such as flooding and wild bush fires are likely to get worse. On the whole, businesses, infrastructure, technology and people are not currently prepared and the impact on asset pricing is likely to be severe.
“An acceleration in policies to mitigate climate change is likely to have a tangible impact on the value of investments”
Companies are starting to embed climate-related risks
The Jupiter Global Sustainable Equities Fund aims to identify the highest-quality companies who are leading the transition to a more sustainable world economy. The positioning of a business through its behaviour, products or services is a fundamental factor in our investment process. We believe companies who manage their business for all stakeholders are better positioned to ultimately benefit. This approach has resulted in a low carbon global portfolio.
Companies with strong climate change management strategies that address the transition to low-carbon sources of energy are more likely to offer long-term sustainable returns, while also helping to mitigate climate change. As the next decade paves the way for clear Net Zero Targets across industries, we see attractive opportunities to invest in companies leading that transition.
“Companies with strong climate change management strategies that address the transition to low-carbon sources of energy are more likely to offer long-term sustainable returns”
Risks and opportunities
Assessing the long-term material risk of climate change to businesses, and the opportunities arising from this, is fundamental to our investment process. Given the complexity of this risk, we use environmental considerations as a tool, and not as a screen. We focus on two factors: the risk; and the opportunity relative to peers and geographical norms.
Profitable, predictable … and happening fast
We think a “green swan” event in the form of decarbonisation is likely to happen much faster than previously projected. Climate change poses a substantial risk to the global economy and human society, and therefore we believe that it is imperative for investors to evaluate climate risk in their portfolios.
As the planet struggles to cope with extreme weather, rising populations and diminishing natural resources, the investment industry has to re-evaluate how businesses can survive and thrive in this changing world. Through the Jupiter Global Sustainable Equities Fund, we aim not only to address the risks to investors’ savings arising from these long-term trends, but also to capture the opportunities.
Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested. The Key Investor Information Document, Supplementary Information Document and Scheme Particulars are available from Jupiter on request.
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This content is for informational purposes only and is not investment advice. We recommend you discuss any investment decisions with a financial adviser, particularly if you are unsure whether an investment is suitable. Jupiter is unable to provide investment advice. The views expressed are those of the fund manager at the time of writing and may change in the future. This is particularly true during periods of rapidly changing market circumstances. Every effort is made to ensure the accuracy of the information, but no assurance or warranties are given. Issued by Jupiter Asset Management Limited (JAM), registered address: The Zig Zag Building, 70 Victoria Street, London, SW1E 6SQ, United Kingdom, which is authorised and regulated by the Financial Conduct Authority. No part of this content may be reproduced in any manner without the prior permission of JAM