Crucially, impact managed funds emerged in Australia. Impact funds are booming overseas as investors favour companies that drive environmental and societal change.
Avoiding harmful sectors and companies is no longer enough; investors want to back climate winners.
In direct investing, local clean tech stocks soared. The Deloitte Australian CleanTech Index, a barometer of 90 stocks, had its best year in a decade, up 32 per cent in 2020.
Behind this glitz of fund flows and product launches was something more concrete: geopolitical developments that have changed climate-change investing.
Within months, climate change has become a bigger consideration for every investor.
Crucial policy developments included Joe Biden’s presidency, and the United States’ return to the Paris Agreement and pledge for net-zero emissions by 2050.
The Trump administration weakened or wiped off 125 US environmental safeguards, according to The Washington Post analysis.
In September, China stunned the world with its promise to have net zero emissions before 2060. As the largest carbon emitter, it needs to show its pledge is genuine. Nevertheless, its long-term aim for carbon neutrality is a turning point for climate-change investing.
Pledges last year from Japan and South Korea to be carbon-neutral by 2050 added to the progress – and reinforced Australia’s lagging approach on climate-change policy.
“There’s been more momentum in climate-change policy in the last six months than at any time in the past decade,” says Phineas Glover, Credit Suisse Australia’s head of ESG research.
“Countries that together account for 63 per cent of global emissions have, in a short period, pledged to get to net zero. The dominoes are starting to fall.”
Glover says this push towards decarbonisation has been faster than financial markets expected.
“Before these changes, it was hard for markets to fully factor carbon emissions into asset prices. There was too much uncertainty about the approach of China and the US, under Donald Trump’s leadership, towards climate-change policy. There’s far greater clarity now.”
Investors must ensure their portfolio is on the right side of the carbon equation.
— Phineas Glover, Credit Suisse
The result is a dramatic impact on the valuations of carbon-affected sectors. For investors, the risk is owning companies that have to write down the value of carbon-intensive assets, as BHP Group did in January when it cut the value of its Mt Arthur thermal coal mine by up to $1.6 billion.
“Companies that have been behind the curve on renewable energy will have to pay a lot more for those assets in the next few years, and others will be left with stranded assets,” says Glover.
“Investors need to act on this change. You don’t want to own a portfolio that has a high allocation to carbon-intensive companies that cannot make the transition.”
The flipside is higher prices for companies with strategically valuable renewable assets. For example, New Zealand renewable-energy utilities that are dual-listed on the ASX mostly rallied over a year (after heavy falls earlier in 2020). Australian utilities that rely more on fossil fuels underperformed.
“Investors must ensure their portfolio is on the right side of the carbon equation,” says Glover. “When looking at a sector, you want to own companies at the forefront in the move towards carbon neutrality. And avoid companies taking too long to act on this issue.”
John O’Brien, a leading clean-technology expert and Deloitte partner, says emotion should be removed from climate-change investing.
“There is no green agenda in this. Companies need to demonstrate they are evolving with the energy transition, to enable both continued access to current investors and a competitive cost of capital.”
O’Brien says three main factors will drive a massive transition to low-carbon assets this decade.
The first is growing investor pressure for companies to report climate-related financial information through the global Task Force on Climate-related Financial Disclosures (TCFD) framework.
The second is growing pressure on companies this year and next to report Scope 3 indirect greenhouse gas emissions.
For example, the carbon intensity of parts a car maker sources from its suppliers. “In the next few years, a manufacturer, such as Mercedes-Benz, could well require that every part that goes into its electric vehicles is carbon neutral, “says O’Brien. “That has profound implications for global supply chains.”
Consumer preferences is the third factor. “Younger people today are starting to want carbon-neutral craft beer and carbon-neutral phones,” says O’Brien. “There’s a huge risk for companies that don’t deliver these products fast enough. You don’t want to own companies that are the last to leave their sector, in terms of the transition to carbon neutrality.”
Nobody doubts that climate change is becoming a priority for industries, boards, banks and institutional investors.
Evidence abounds that climate laggards will pay more for capital and find it harder to attract investors, customers and employees.
Laggards also risk heightened shareholder activism from superannuation funds that are responding to member concerns on climate change, and from environmental activist groups that attack listed companies at annual general meetings.
However, the rush to allocate capital to low-carbon-emitting assets could fuel the next great sharemarket bubble: renewables. Total confirmed investment in renewable assets was $US1.85 trillion ($2.39 trillion) globally in February 2021, notes Credit Suisse.
This will hurtle towards $US4 trillion if Biden’s proposed Green New Deal stimulus package is approved.
It’s not just governments and equity markets investing in renewable assets – across asset classes, the race is on to add sustainability to the mix.
Witness the boom in green bonds and now sustainability-linked loans, where airports and other infrastructure assets pay less for debt if they meet carbon targets.
“Entire balance sheets are trying to find the best renewable assets,” says Glover. “With that comes the risk of valuation bubbles. We’ve seen a huge increase in valuations for renewable assets globally in the past six months, and clean-energy companies trading on sharply higher multiples. Some valuations are starting to become disconnected from reality.”
Tesla’s $US680 billion valuation is a prominent example. Those who believe the visionary electric vehicle company will transform energy markets over 50 years can justify its staggering valuation.
For everybody else, Tesla is wildly overpriced.
Also, if market interest in renewable assets overshoots, companies on the wrong side of the equation could become badly undervalued.
Climate change supporters say the coal industry is in terminal decline, yet sector leader Whitehaven Coal’s share price has risen 70 per cent over six months.
Like other coal stocks, Whitehaven is well off its peak share price. But savvy investors know good money can be made in declining industries.
The market sometimes has a blinkered view on out-of-favour sectors, ignoring company fundamentals and valuations, or the possibility of some high-emitting companies making the transition to lower emissions.
Climate-change investing has been prone to hype and “greenwashing” over the years. Some funds promote their green credentials to attract money, even though they have limited ESG screening or hold stocks that are inconsistent with investor values.
Some large ethical funds overseas even held oil and tobacco stocks until a few years ago.
In Australia, some top-performing sustainable funds have high allocations to buy now, pay later stocks that arguably facilitate excessive consumerism, and retailers that still own poker machines.
Also, investing directly in low-carbon emitters is challenging. More than 40 per cent of Australia’s largest 200 listed companies have insufficient climate-change plans and reporting, according to a recent analysis by PwC.
Comparing listed companies on emissions is hard because some in the ASX 200 index still don’t report this information and most don’t include the carbon impact of other firms in their supply chain.
ESG analysts have to estimate this information, meaning sharemarket indices that purport to include low-carbon companies are based partly on proxies rather than the real thing.
Using sustainable managed funds is equally problematic.
Choices in Australia are limited, even though climate change investing is hardly new. More such retail funds are on the way, but local product issuers collectively have not kept pace with investor attitudes towards climate change.
Fund labelling and education on sustainability investing are mostly poor. Only one Australian large equity fund that received Morningstar’s Low Carbon Designation, which denotes portfolios with low carbon risk, had an explicit sustainability objective.
Even worse, terms such as “sustainable”, “ethical”, “ESG” and “impact” are often interchanged in fund marketing, despite meaning different things.
This can confuse small investors.
Fund reporting on climate-change investing is also patchy. Impact investor Melior Investment Management publishes a detailed report annually on environmental and societal outcomes from its investee companies, and its board engagement.
Such reports are still rare for retail investors here, making it hard to understand a fund’s societal return and compare it with others in its sector and its benchmark index.
Moreover, for all the talk, only 6 per cent of Australian equity funds received the Morningstar Low Carbon Designation rating.
In the US and Europe, 70 per cent of funds have that rating.
This gap is partly because of the composition of Australia’s sharemarket. We have more mining and energy companies (by sector weighting) compared with US and European sharemarkets, and fewer technology and healthcare companies with low emissions.
It is also true that Australian fund managers have generally lagged their overseas peers on climate-change investing.
Morningstar director of manager research Grant Kennaway says the gap is also because of Australia’s policy approach.
“Markets thrive on confidence, and both sides of politics here have provided little confidence on climate change policy,” he says.
“Australian companies have had less regulatory certainty to invest in renewables, and that is reflected in the make-up of our sharemarket and the carbon ratings of equity funds that invest in local shares. Australia is still miles behind European markets on investing for climate change.”
Change is coming, he says. “Asset managers are starting to get the message. They’re designing their funds to be more contemporary on sustainability issues, responding to investor preferences to invest in low-emitting companies, and improving reporting on the fund’s ESG performance.
“They have to: superannuation funds are exerting more pressure than ever on fund managers to adapt to climate-change risks and opportunities.”
Melior ’s Lucy Steed says some of the best climate-change opportunities will be in high-emitting companies that can make the transition to lower emissions.
She cites BlueScope Steel and Fortescue Metals Group as examples.
BlueScope Steel is developing green steel technologies and recently appointed Gretta Stephens as its CEO of climate change to lead the company’s decarbonisation efforts.
Fortescue has pledged 10 per cent of annual profits from its iron ore business to the company’s Future Industries Division.
More than $1 billion of shareholder funds could be invested across
clean-energy initiatives, such as hydrogen projects, transforming Fortescue.
“Investors need to identify companies getting on the front foot and positioning for a lower-carbon world,” says Steed.
“You can’t only look at renewables companies: climate change affects all industries. Some companies in traditional industries could do very well from adopting renewable technologies that in time transform their operations and business model.”
With risk management, avoiding companies that might have stranded assets is not enough, says Steed. “Investors also need to consider suppliers that provide products or services to these assets.”
Rail operator Aurizon Holdings, for example, relies on hauling coal.
Regulatory risk is another consideration.
“Australian exporters to Europe should be increasingly concerned,” Steed says. “It’s likely they will face new carbon-related taxes from manufacturing and shipping their products to that market.”
The European Parliament this year endorsed a proposal for a Carbon Border Adjustment Mechanism (CBAM), to even the playing field between producers subject to the EU emissions trading scheme, and those in countries that do not currently price carbon.
Steed says investors must recognise the speed of change in climate-change investing.
“A year ago, people didn’t talk much about net-zero carbon emissions. Now, ‘net zero’ comes into our conversations with companies and boards all the time.
“Climate change is the great megatrend of our time. Investors need to position for that change or risk being left behind.”