Climate change is getting real for investors

Climate change updates

Sign up to myFT Daily Digest to be the first to know about Climate change news.

Europe’s gas crisis is a warning that climate change is rapidly morphing from a faraway prospect for investors to a direct input into asset allocation decisions.

The transition away from the dirtiest fossil fuels is not the only reason for the spectacular rally in UK natural gas prices, which have almost tripled this year.

Russia has been slow to refill Europe’s gas storage that was depleted by the last long, cold winter. The state-controlled energy group Gazprom has been fulfilling long-term contracts but has not stepped up with extra short-term supplies. On the margins, peculiarities such as a lack of wind in the UK this summer (who knew?) have also boosted reliance on this fuel.

Still, efforts to green up our energy have contributed. Europe has been phasing out coal power plants, and the price of permits to emit carbon in the UK and EU has rocketed this year, making it painfully expensive to keep on burning coal. That makes gas, while still a fossil fuel, an essential and cleaner alternative.

The impact on companies, from food processors to fertiliser manufacturers, has been severe. To prevent households and businesses from having to turn off the lights or shiver through the winter, governments also are stepping in with billions of euros in support.

A long-term solution, with fully renewable energy, implies massive investment and intense demand for the commodities that make wind turbines and batteries.

This is no longer something investors can afford to ignore. Television screens filled with images of floods and fire have strengthened asset managers’ resolve to try and do the right thing. But what really spooks them is the sobering image of rising natural gas price charts and the growing realisation this might hit where it really hurts: in their returns.

It is becoming, in investment parlance, a macro risk. The finance industry’s fondness for a portmanteau means it already has a name: greenflation.

For fund managers, macro risks generally encompass the big global shifts that underpin their strategy: geopolitics, the ascent of China, the broad sweep of global monetary policy, and so on. Climate is now earning a place on this list.

“It is in the realm of macro,” said David Riley, chief investment strategist at BlueBay Asset Management. “It is now a medium- and short-term issue that relates to inflation, growth and public finances. It implies much lower consumption. It is not going to be a costless transition.”

Up to now, the simmering planet has largely been a cause for hand-wringing among investors, many of whom have sought, generally with the best of intentions, to help turn the situation round. Investment strategies that either encourage sustainable behaviour, or punish wrongdoing, have blossomed into a vast industry in huge demand.

Some of the tensions and contradictions at the heart of that industry have shot into the spotlight lately. For a fund, how virtuous is virtuous enough? Does sustainable investment actually do any good? Are asset managers making promises they cannot keep?

It is important to get this stuff right. But these concerns have an element of counting the deckchairs on the Titanic. The real response that is needed becomes more urgent as the earth continues to heat up.

With COP26 climate talks coming up before the end of this year that no doubt herald a sweep of new government announcements, Barclays has already sought to remind clients to take seriously the risks to portfolios that this implies.

“With the direction of travel becoming increasingly clear, financial markets participants would be well advised to anticipate measures [such as carbon trading schemes and carbon taxes] and plan accordingly,” the bank said in a note this week.

Investment house Fidelity International addressed this issue in a report this summer. Its view is that most money managers are still failing to see the immediacy of this issue.

“Mainstream long-term macroeconomic projections, and consequently consensus capital markets assumptions used by the investment industry, underplay both the magnitude and geographical dispersion of climate change impacts on key macroeconomic variables such growth and inflation,” it said.

An impact is likely whether we try and halt the effects of climate change or not. For example, emerging-market equity returns are particularly vulnerable if we keep going as we are and leave the planet to fry, Fidelity warns.

Right now, the debate on inflation, and how persistent it will prove to be, centres on the economic bounce back from the coronavirus pandemic, and how long supply-chain logjams will continue.

If Fidelity is right, that gives only part of the picture: “While a number of factors putting pressure on inflation currently are most likely to be transitory, we believe policies to achieve net zero by 2050 have the potential to bring out more persistent inflationary forces which are still not discounted by the markets and are underestimated by investors.”

katie.martin@ft.com