World Leaders and Investors: Similar Dilemmas
On November 30, world leaders will meet in Paris at the Conference of Parties (COP21) in an attempt to construct a global climate agreement that will put the world on a path to a more sustainable future. The deliberations necessary for this agreement will be complex, require sacrifices, and will involve a combination of political, economic, and social considerations.
During these deliberations, world leaders will face some dilemmas that are familiar to long-term investors. Governmental commitments to reduce greenhouse gas emissions will likely be effected through a carbon tax or cap and trade system. Both mechanisms put a price on carbon that increases costs to suppliers and consumers of fossil-fuel-based energy. One might view the resulting costs as long-term investments in a more sustainable physical environment, the hope being that making investments now will limit the negative future economic and social consequences of climate change. The time horizon between investment and value realization is prolonged in the climate context, because most of the benefits derived from the decisions made at COP21 will manifest themselves over a period of many decades. Politicians and policy makers at COP21, therefore, are dealing with a difficult situation, in part because a number of their citizens (voters) simply don’t want to pay what they consider to be an additional tax for a benefit that that they believe may not benefit them directly.
As mentioned above, long-term investors face similar dilemmas to those that the COP21 participants are dealing with. Many institutional asset owners and managers characterize themselves as long-term investors, but the industry practices around recognition and reward make it difficult for investors and therefore the leaders of their underlying companies to make long-term decisions. Fiduciaries, asset owners, and money managers operate in an environment where short-term performance pressures can override long-term thinking. The pressure from shareholders on companies to produce quarterly results often scuttles strategic initiatives that could generate long-term value in favor of tactics that will improve today’s bottom line. People tend to act in a manner that produces outcomes that result in a favorable performance assessment, and frequently that assessment is based on near-term results.
The Near-term Opportunities
What does the current state of things mean for long-term investors? The move to a low-carbon economy will present both risks and opportunities as environmental sustainability moves from being a mainly mission-driven initiative to one with economic considerations. While a shift in energy sources will take time, when capital market prices adjust to the market, those at the forefront of understanding the inevitability of the shift should be able to reap some rewards.
Across the current investment landscape, we see four major climate-related trends emerging:
- stranded assets
- carbon efficiency
- the rise of renewables
In whichever way investors express their views on climate change, they have the opportunity to enhance portfolio performance while allocating capital in a manner that simultaneously addresses climate risk and promotes environmental sustainability. A clear message and commitment from COP21 will help to reduce uncertainties around the desire to price carbon. And while individual cap and trade or tax schemes need to materialize, investors should be more confident in allocating capital with increased certainty of a global commitment. Those at the forefront of addressing climate risks in their portfolio construction should have a first mover advantage.
The Bigger Picture
In closing, holding COP21 in the city of Paris, a city that has survived two terrorist attacks this year, will serve as a stark reminder that issues stemming from climate change are not just limited to the environment. They are political, economic, and social. Dealing with terrorist threats will likely require some combination of military activity, enhanced intelligence, and a deeper understanding of the root causes of inhumane ideologies, so that those threats can be reduced. I will suggest as Tom Friedman has done many times that the West’s dependence on fossil fuels is a factor in the current social conditions we are seeing in the more violent regions of the Middle East. Like finding solutions for terrorism, dealing with climate change requires a multi-pronged approach. We cannot lay responsibility on or seek solutions solely from fossil fuel companies, industry, capital markets, or government policy.
The world needs civil and levelheaded discourse to solve the critical global problems that we face. We need policy makers with the courage to craft clear and bold climate policies, investors who truly invest for the long term, and perhaps most importantly, citizens that believe in generational equity. Efforts around preserving a livable climate and reducing the risk of catastrophic outcomes for future generations is the epitome of paying it forward—doing something today for which you expect no immediate reward; in other words, it amounts to investing for the long term. See, for example, “The World’s Hot Spot,” The New York Times, Aug. 19, 2015.