There is mounting evidence to suggest investors will benefit from supporting products and services focused on achieving a warmer but lower carbon world.
It is clear to see that any economic activity related to fossil fuels is facing substantial headwinds, not only on the demand side, but also from a policy and regulatory perspective, notes Aviva Investors.
On the flipside, said Jaime Ramos Martin, portfolio manager at the fund house, economic activities that eliminate or significantly reduce the use of fossil fuels are likely to experience demand and policy tailwinds.
“Climate change brings physical impact risk that can meaningfully affect economic activity, for example, extreme weather events could disrupt supply chains,” he said as part of a webcast entitled “Managing through the climate transition”.
As a result, investors need to be mindful that businesses which appear to have a small carbon footprint are in reality much more exposed to climate change risk.
“Companies should be evaluated not only based on direct emissions from activities in their own operations, but also the indirect emissions from its value chain to fully grasp the risks,” explained Martin.
Much more to be done
A significant risk stems from the fact that policymakers seem to be well behind in implementing the necessary measures.
At the same, Martin said disclosures still leave a lot to be desired and most management incentives do not consider climate change.
This all needs to be addressed since it is increasingly apparent that the consequences of climate change are not just ecological; it has the potential to cause harm in societal, economic and political terms.
As a result, without any policy action to limit CO2 emissions, there is a possibility that global temperatures would rise to over four degrees above pre-industrial levels by the end of the century. “The current policies in place suggest that a target of around three degrees is feasible, while the Paris agreement targets two degrees,” said Martin.
A report from Oxford Economics suggests global GDP could be suppressed by over 20% in a three-degrees scenario, he added.
Three steps to climate-focused portfolios
To help investors incorporate a focus on climate change in a portfolio – and in turn deliver returns and drive change – Aviva Investors has designed a three-step process.
The first of these is fossil fuel exclusion. “The Paris Agreement emission target states that only 20% of known fossil fuel reserves can be burned. We decided to exclude fossil fuel stocks from the study,” said Martin.
The second step is to identify those companies that have a positive impact by providing solutions that either help to mitigate climate change or adapt to the consequences of climate change.
Finally, the firm has developed a proprietary model to identify the companies already preparing for a warmer, lower carbon world. “[This] highlights those that are getting ready for the transition by incorporating climate change into their business models,” explained Martin.
He believes it is important to follow a specific stock-picking process. This includes: being style agnostic, to ensure there is no limitation of stock types; being change driven, to focus on the potential changes instead of the past; and taking a “connected thinking” approach, to lever global connected resources to identify stocks for portfolios.
