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Is climate change influencing your investment strategy?

Climate change risks to investment portfolios are an important consideration for many investors. But understanding how climate change affects asset allocation can be tricky. It takes careful research to find out the best approach.

Whatever your view on climate change, it’s beginning to affect the investment decisions of companies and individuals in market sectors across the spectrum, from property and tourism to banks and energy.

“Our view is that climate change and, more broadly, environmental, social and governance (ESG) issues are risks that need to be managed,” says Colonial First State’s Head of Investments, Scott Tully.

But understanding the risks, let alone trying to pick winners and losers, is more difficult than it might seem. The science of climate change is complex and the data that would help individuals make informed decisions often isn’t there.

According to the UN-endorsed, Principles for Responsible Investment (PRI), only 10 per cent of investment managers and 11 per cent of asset owners have integrated climate change into their asset allocation strategy.

If you’re investing in property or infrastructure investments, climate change risks might be location and asset specific.

Managing the risks


It’s not necessarily a particular market sector itself that’s most at risk but companies within sectors failing to recognise they face operational and financial risk from climate change.

The question for investors is how well companies are managing the transition to new technologies rather than keeping their heads in the sand, says Tully.

“Are they recognising that carbon-related technology changes will impact their business models? Are companies setting themselves up for success?”

Take the example of AGL Energy, one of Australia’s largest and oldest energy generators. At face value, it’s at risk from climate change because it generates electricity from fossil fuels, particularly coal. But it is also Australia’s largest ASX-listed owner, operator and developer of renewable energy from solar, wind, landfill gas and hydroelectricity.

In other words, AGL is actively managing the transition to a new clean energy environment. Ideally, this will be of benefit to its shareholders but there will be risks in managing the transition. There is also risk associated with the current uncertainty in government climate and energy policy and these risks need to be assessed when deciding whether to invest in a company.

Location, location

“If you’re investing in property or infrastructure investments, climate change risks might be location and asset specific,” says Tully. For example, properties or infrastructure assets located along the coastline in certain areas may have an increased probability of flooding or other adverse weather impacts.

The location risk extends to insurance companies as well. Investors need to analyse the portfolio of underlying risks that the company is insuring. Does an insurance company have a disproportionate exposure to regions that have a higher probability of extreme storm damage? Is this risk appropriately reinsured? What does long term climate change mean to the value of assets that the insurance company holds as its reserves?

Within each asset class there are idiosyncratic risks and examples of companies taking advantage of opportunities to mitigate those risks. Some property developers have done a lot to improve the energy efficiency of their buildings by incorporating sustainable materials and design. This provides a healthier environment for people to live and work in as well as reducing energy costs and the likelihood of expensive retrofits in future.

As an investor, you may want to know which property investments incorporate sustainable materials and design in their buildings or which food companies use ingredients from sustainable sources. But good practices in one area can be let down in others such as poor corporate governance or workplace safety.

A portfolio approach

“We’re deliberately not adopting an approach that tries to pick winners but are moving towards an approach that manages risk for our investors,” says Tully. It’s not just about providing ESG specific investment strategies, although Colonial First State does do that, but embedding responsible investing across the entire range of investments.

To that end, Colonial First State is a signatory to the Principles for Responsible Investment. These principles include incorporating ESG issues into investment decisions, being active owners, seeking appropriate disclosures on ESG issues from entities it invests in and reporting on progress in implementing the principles.

At the same time, Colonial First State is also drilling down into its portfolios to extract the data it needs to help investors make informed decisions.

“We’ll be measuring the carbon footprint of all our investment options. This will give us an indication of the carbon intensity of investments, how much carbon companies in our portfolios are emitting and whether they are increasing or decreasing their emissions over time,” says Tully. That information can then guide Colonial First State in constructing portfolios that manage the risks, and the opportunities, presented by climate change.

A virtuous circle

Whether you want to invest with a social conscience or protect yourself from financial losses – or both – asking the right questions and getting the right information is the key to success. As responsible investing gains momentum, companies and asset managers will have even more incentive to respond to the challenges of climate change.

Getting great advice

As you can see, there’s lots to think about when deciding on your investment strategy. That’s why it makes sense to talk to a financial adviser who can help you find suitable investment options for your individual financial situation.

Disclaimer
Colonial First State Investments Limited ABN 98 002 348 352, AFS Licence 232468 (Colonial First State) is the issuer of super, pension and investment products. This document may include general advice but does not take into account your individual objectives, financial situation or needs. You should read the relevant Product Disclosure Statement (PDS) carefully and assess whether the information is appropriate for you and consider talking to a financial adviser before making an investment decision. A PDS for Colonial First State’s products are available at colonialfirststate.com.au or by calling us on 13 13 36.