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Climate Change- from Risk to Opportunity

Climate Change- from Risk to Opportunity
from Risk to Opportunity

Humans are waging a “suicidal war” on nature... Making peace with nature is the defining task of the 21st century. It must be the top, top priority for everyone, everywhere.

UN Chief, António Guterres, ‘State of the Planet’ speech, 2 December 2020

Climate risk is unquestionably one of the largest risks facing humanity. The World Economic Forum 2021 Global Risk Report ranks environmental risks as four of the top five by likelihood, with “infectious diseases”, even in the midst of a global pandemic which has taken more than 3 million lives, coming in only in fourth place (Exhibit 1). Turn it on its head, though, and the severity of climate risk is paving the way for some of the greatest investment and impact opportunities in the decades to come.

Exhibit 1: Top global risks by likelihood (rank)
Source: World Economic Forum

CO2 levels today are higher than at any other point in the past 800,000 years (Exhibit 2), having risen dramatically since the Industrial Revolution, significantly amplifying the greenhouse effect and suggesting it is driven by human activity.

Exhibit 2: CO2 emission levels over the past 800,000 years
Source: NDAA, Climate.gov, Robeco

Although global CO2 emissions fell by 9% in the first half of 2020 as a result of the outbreak of COVID-19, a similar decrease is required every year for the next decade to limit global warming to +1.5°C. Alas, with the pledges and policies in place as of December 2020, we are still heading towards a calamitous +2.7-3.1°C world.

Exhibit 3: 2100 warming projections (based on pledges and current policies)
Source: Climateactiontracker.org

According to David Wallace-Wells, author of The Uninhabitable Earth, at +2°C, “major cities in the equatorial band of the planet will become unliveable. Even in northern latitudes, heat waves will kill thousands each summer”. At +3°C, “southern Europe would be in permanent drought … the areas burned by wildfires would double in the Mediterranean and sextuple, or more, in the United States.”

There is no question that massive steps need to be taken urgently for this not to become a reality. Greta Thunberg would most likely disagree, but it is encouraging that governments have stepped up their climate pledges (although she has a strong point in that many pledges need to be converted into transparent and effective policies and actions).

Exhibit 4: Climate pledges
Source: Financial Times, April 2021

The UN Chief, in his powerful “call to arms” speech in December 2020, stated that an “imperative” in addressing the climate crisis was to align global finance behind the Paris Agreement. International Renewable Energy Agency (IRENA) estimated in March of this year that a whopping $115 trillion of investments are needed in clean technologies globally through 2050 to limit global warming to +1.5⁰C. Also, only a few weeks ago, US Treasury Secretary, Janet Yellen, stated:

The investments needed to green our economy is enormous. One estimate placed the needed incremental investments at over $2.5 trillion for the United States alone … private capital will need to fill most of the gap.

So, in addition to government policies and spending, private investors have a unique and noteworthy role to play as part of the solution to the climate crisis, and investors can benefit from the tailwind from government action and changing consumer sentiment. But which are the most effective and compelling opportunities? To answer this question, we need to look at the sources of greenhouse gas emissions (Exhibit 5).

Exhibit 5: Greenhouse gas (GHG) emissions in 2016
Source: ourworldindata.org

Around 73% of all GHGs come from energy use and, within energy, close to 24% from energy use in industry, just over 17% from energy use in buildings and 16% from energy use in transportation. Other top GHG contributors are agriculture, forestry & land use at over 18%. A key takeaway from Exhibit 5 is that GHGs are coming from a wide array of sources and, to tackle the crisis, investments need to be made across the spectrum. Furthermore, it is obvious that there is a vast amount of interconnectivity, particularly within energy, further highlighting the importance of tackling the GHG sources within the sector.

It is a daunting enough task to eliminate climate risk from investors’ portfolios. If you then want to allocate to climate change opportunities, complexity only rises. At ARP, we have created our own proprietary breakdown of how to allocate to the space, which aligns to the sources of GHG emissions and therefore to the solutions to the climate crisis (Exhibit 6).

Exhibit 6: ARP areas of focus from an investor’s perspective
Source: Absolute Return Partners

Many of the opportunities are in technological innovations, or what Bill Gates likes to call “breakthroughs”, such as green fuels (see our recent ARP+ paper on hydrogen), the carbon capture and storage (CCS) technology, agtech, etc. However, some of the solutions (and investment opportunities) do not rely on technology, such as afforestation or a carbon emissions market. A benefit of investing in climate change opportunities is the impact angle with for example the Climate Action United Nations Sustainable Development Goal (SDG) being addressed.

Exhibit 7: SDGs investors can address by investing in climate change
Source: United Nations

Not all the opportunities identified in Exhibit 6 can be allocated to across all investment strategies, with for instance Stranded Assets accessible almost exclusively through equity long/short funds. The most easily accessible and versatile areas to invest in are GHG Reduction Technologies and Circular Economy as they can be accessed via a broad array of investment strategies (Exhibit 8).

Exhibit 8: Mapping the climate solutions to investment strategies
Source: Absolute Return Partners

The opportunities across the investment strategies are very distinct and varied, and we will be producing an ARP+ paper discussing the wide-ranging opportunity set in much more detail. So, once you have addressed the climate risks in your existing portfolio and are ready to actively participate in the ensuing opportunity, we believe it is important you explore this broad opportunity set. There is no doubt to us, that to be part of the climate solution, investors should be thinking further afield than, for instance, simply investing in the latest climate-aware exchange traded fund (ETF).

Alison Major Lépine

3 May 2021

For more on climate change opportunities, please email us: info@arpinvestments.com

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About the Author

Alison Major Lépine joined Absolute Return Partners in 2015 after almost 10 years at the UK Railways pension scheme where she was responsible for over £1bn in various absolute return strategies. She is a Partner and Head of Strategy at the Firm.