The climate change challenge

By Jayson Forrest - Managing Editor  - IMAP Perspectives

The net zero carbon transition is providing investors with a range of opportunities in the ethical and climate-responsible investing space. Leah Willis and Dr Stuart Palmer discuss the growing appetite by investors for this type of investing.

With greater consumer and market awareness about issues like climate change, fossil fuels, and a perception of unethical practices of some companies and sectors, it’s unsurprising that the trend towards ethical and responsible investing continues to gain momentum in this country.

The latest findings from the Responsible Investment Association Australasia (RIAA) - which advocates for responsible and sustainable investing in Australia and New Zealand - supports this trend.

In its 2021 Responsible Investment Benchmark Report, RIAA reports that the Australian responsible investment market continues to grow, with assets under management (AUM) increasing by $298 billion to $1,281 billion in 2020, while the AUM managed by the remainder of the market decreased by $234 billion to $1,918 billion.

According to RIAA, the proportion of responsible investment AUM to total managed funds in Australia was 40 per cent at December 2020, compared to 31 per cent in 2019. This growth in the Australian responsible investment market mirrors global trends that shows that sustainable investments have reached US$35.3 trillion in AUM, now equating to 36 per cent of all professionally managed assets, according to the Global Sustainable Investment Alliance.

It was against this backdrop that Australian Ethical’s Leah Willis - Head of Client Relationships - and Dr Stuart Palmer - Head of Ethics Research - addressed increasing investor concern over climate change at the 2022 IMAP Advice in Action conference.

According to Leah, Australia has witnessed a significant shift in how investors view ethical and responsible investing.

“Responsible investment in Australia has continued to soar in popularity to $1.2 trillion in 2020,” says Leah. “They are 40 per cent of total AUM and grew at 15 times the rate that overall professionally managed investments have grown in Australia.

“Investors are realising that their money can be harnessed to deliver both competitive returns and positive change for society and the environment. And they don’t have to sacrifice returns to invest ethically. RIAA reports that responsible investment fund performance returns in 2020 were on par with, or better than, the market, even though overall fund performance was down largely due to the impact of COVID-19 on economies worldwide.”

According to Leah, ethical investing represents a significant opportunity for advisers, with research from Investment Trends showing that the majority of investors either believe they already consider ESG principles when investing (33 per cent) or intend to do so in the future (45 per cent).

“That’s almost 80 per cent of investors who have an interest in ethical and responsible investing,” says Leah. “It’s therefore important for advisers to engage in ethical and ESG investing conversations with their clients, as well as consider including this style of investing in their value proposition.”

However, Leah concedes that the topic of ESG is not easy, with numerous complex issues for advisers to navigate. One of these issues is the transition to a net zero carbon economy. Yet despite many of the world’s largest companies committing to net zero targets by 2050, projected capital expenditure in the energy sector is not aligned to net zero targets, which makes the risk of stranded assets very real.

“In order to reach net zero emissions by 2050, the International Energy Agency estimates that annual clean energy investment worldwide will need to more than triple by 2030 to around $4 trillion per annum. And on top of that, we need to consider the costs involved for the transition in transport, food and building materials,” she says. “This isn’t going to be an easy or cheap transition.”

And although many companies are now getting onboard the ‘green’ bandwagon and spruiking their ethical and ESG credentials, Leah warns that not all green is good and not all ethical companies are financially viable. She says advisers and investors need to carefully conduct their research in order to navigate ‘greenwashing’, mispricing risks and valuation bubbles when investing ethically and responsibly.

Dr Stuart Palmer agrees that the race to ‘net zero’ will create many challenges for both advisers and investors, particularly in relation to climate-responsible investing.

Climate-responsible investing is the investment in organisations, projects or funds with the intention of generating measurable environmental outcomes by decreasing global carbon emissions, alongside creating a financial return.

“The biggest social and economic risks we face are related to climate change,” says Stuart. “The current warming of the planet is unprecedented in more than 2,000 years. The impact of global warming is clearly apparent, with more intensive bushfires, severe droughts, floods and unseasonal weather conditions. This is already impacting agriculture and the production of food.”

However, in response to concerns about changes to climate, Stuart reports there has been a boom in net zero energy investment, particularly in renewable energy, like solar and wind generation, electric vehicles and emerging alternative energy sources, like hydrogen.

“But even with this net zero energy investment boom, we will still be reliant on using fossil fuels as part of our energy mix for some time to come,” says Stuart. “But there is already huge investment in sustainable energy alternatives, and good progress being made with them.”

He refers to German energy company, HH2E, which has recently invested €1 billion in a plant to produce green hydrogen in northern Germany. This decision was partly in response to cut Germany’s dependency on Russian gas, as well as a move to provide more reliable and cleaner energy.

“There is still uncertainty about the demand for hydrogen, but there is definitely an opportunity in producing it. Just look at Fortescue Future Industries, which has entered a long-term agreement with Covestro, to produce and supply green hydrogen and its derivatives, including green ammonia.”

Leah Willis is Head of Client Relationships at Australian Ethical; and Dr Stuart Palmer is Head of Ethics Research at Australian Ethical.

They spoke on a session titled - ‘Responding to clients’ climate change concerns’ - at the 2022 IMAP Advice in Action Conference.