Five insights in five minutes
Cop 026 and finance 101
Investors in the pubs – sorry, conference rooms – of Glasgow next week are advised to leave climatology to the experts. Equally, decarbonisation does not change the immutable laws of finance. So how to think about net zero from an investment perspective? First, be careful not to confuse volume with value. Heavy emitters may suffer lower demand, but that doesn’t mean share prices must fall or credit spreads widen. Industries respond, capacity is cut, cashflows are managed – and of course there are lots of other factors that influence asset prices. Same goes for supposed ‘winners’ of the transition. Note the 15 per cent fall in global clean energy indices this year, per the chart below. Second, understand what valuations are telling you. For an equity with a price/earnings ratio of ten times, for example, global temperatures in twenty years are irrelevant. Not so for ultra-high PE companies whose market caps are supported by forecast earnings decades from now. Finally, ignore the doom-mongers! Stock markets at record highs certainly are. Five in Five was once laughed at for predicting that trillion dollar businesses would emerge from the transition. Hello Tesla.
Conversation starter for... climate change funds, global equities, global credit, green bonds
Adaptation vs mitigation
At events such as Cop26, the spotlight is usually on mitigation, the act of lowering greenhouse gases released into the atmosphere – leaving adaptation (the reduction of vulnerability to climate change) in the shadows. Indeed, 95 per cent of global funding for climate action in 2018 went on mitigation, estimates HSBC analysts, as shown in the chart below. Meanwhile, the Independent Expert Group On Climate Finance reckons that adaptation’s overall share in climate public finance was a mere 20 per cent last year. That’s unfortunate, as adaptation is highly effective. Worldwide climate related deaths have fallen from roughly half a million annually a century ago to 20,000, according to the OFDA/CRED disaster database, thanks to better infrastructure, housing, flood defences, early warning systems and so on. Amsterdam lives happily two meters below sea level. But much more adaption funding is required as global surface temperatures will rise until at least mid-century. The role and opportunity for investors, highlighted in the ‘Just transition’ note below, is huge.
Conversation starter for... ESG strategies, emerging market assets, climate funds
Emissions and trade
Countries love pointing fingers at Cop26, especially when it comes to emissions. But apportioning blame is complicated. Imagine you want to make cars, but choose to build a plant overseas. Who should ‘own’ those emissions? And would your answer change if those cars were purchased locally or exported back home? Just as nations have goods trade balances, therefore, so too carbon trade balances – with some importing more emissions than they export, and vice versa. China, for example, produces about 12 billion metric tonnes of carbon dioxide per annum. However, two billion were emitted in the manufacture of exports last year, while almost 900 million were imported. As can be seen below, China runs carbon trade surpluses in every sector, the biggest being high-emitting construction materials, which account for about 15 per cent of exports, according to Bloomberg data. Taking all this into account, it can be argued that China’s true emissions numbers should be a tenth lower, based on scope one and two emissions. Conversely, America’s should be six per cent higher, as you might expect given the size of its trade deficits.
Conversation starter for... China equities, global equities, Asia credit
If Cop26 is going to turbo-charge (a prize to the reader who comes up with a battery equivalent of this verb) the green bond market, it hardly needs the boost. Financing increased 60 per cent over the past 12 months and is expected to reach one trillion dollars by the end of December. This is in line with Moody’s expectations of USD450 billion of green bonds to be issued worldwide this year, up from around USD300 billion in 2020. As illustrated below, developed countries have dominated the green bond market and still represent three-fourths of total volumes. But note the shift of activity to emerging markets, particularly Asia. For investors, higher volumes mean valuations should be less impacted by scarcity. And as most developed market bonds offer negative yields these days, emerging company green bonds of comparable credit quality are an attractive option. Especially as the ‘greenness’ of the latter becomes more transparent and standardised.
Conversation starter for… green bonds, emerging green bonds, Asia credit
For investors with a keen focus on emerging markets, one topic to follow at Cop26 is rich world pledges to developing nations. The latter are already feeling hard done by, having six years ago been formally promised USD100 billion per year by 2020, only now to be told there’ll be a three-year delay. Funding for emerging markets to aid the transition to a lower carbon future is crucial, especially as they will also endure the brunt of climate change effects in years to come. And cutting emissions without adequate green investment would harm their growth. The UNEP estimates the annual adaptation costs of developing countries at up to USD300 billion by the end of this decade, ramping towards USD500 billion by 2050. In other words, a commitment of only a fifth of that barely touches the sides. Rich governments have to do more. But it is clear the opportunity for private financing to bridge the gap is immense.
Conversation starter for… emerging market equities and credit, green bonds, private equity
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