/ 21 January 2013

Investors gamble by ignoring climate constraints

Investors Gamble By Ignoring Climate Constraints

This is the conclusion of a report by the Institute and Faculty of Actuaries. A comprehensive look at what global investors are thinking, it found that while there is no question that resources will be squeezed in the future, asset managers did not consider this in their decision-making process.

"Currently, actuarial models are effectively discounting to zero the probability of economic growth being limited by resource constraints," it said.

"The most extreme scenarios modelled represent financial disaster; the assets of pension schemes will effectively be wiped out and pensions will be reduced to negligible levels," it said. And this extreme scenario is based on business-as-usual and things continuing just as they are now.

At best these constraints will lead to an increase in energy and commodity prices, and at works create an uncertain and unstable economy, it said.

And while the world economy can now adapt to face a shortage of one resource – like oil – there would be too many things in shortage for this mechanism to work.

The problem is a simple one on paper. Modern economies work on borrowing from the future, so have large levels of debt. They therefore have to keep growing to pay back this debt and create more consumers to grow further. But if they decline the debt will increase in relation to the size of the economy, leading to stagnation and unsustainability.

This stagnation will destroy the values of pensions, and mean people with nothing have no chance of doing better. And this will have huge implications for civil unrest, the report found.

Depletion of natural resources
The often-cited discussion around this is Diane Coyle's The Economics of Enough. And her conclusion is that current western economic policy has "borrowed from the future on a significant scale". This is through the accumulation of debt to finance consumption now, or through the depletion of natural resources and social capital.

This will then come back to haunt the system as there is not enough material to continue growth, and the external costs of the previous growth hit home, she writes.

Alec Joubert, principal consultant at Camco Clean Energy, said that except for reinsurers, few investors are getting to grips with how climactic changes will affect their portfolios.

"The problem is people are not aware that we are facing a problem and there is nothing to force change. That is because we have not yet seen the kinds of large-scale changes and catastrophes that have pushed change overseas," he said.

Where business and asset managers are dealing with the future costs from climate change is with the costs of mitigation (changing the way they do business to pollute less), he said. But in general their problem was a lack of knowledge and the newness of the issue.

A recent report by the World Wide Fund for Nature also found that companies and investors were not factoring environmental costs into their planning – where environmental costs are represented by legislation, like a carbon tax, which forces these costs onto companies.

Short-term performance fixation
Malango Mughogho, its lead author, said, "The carbon tax is coming and things like that have not been taken into account by investors."

This would leave the value of their investments inflated. Something like a carbon budget, which would force things like coal to be left in the ground so they would not add to carbon emissions, would severely affect these investments, the report found.

Mughogho said it was also clear from the way brokers are rewarded that companies are focused on short-term profitability. "They cannot be rewarding long-term considerations," she said.

Graham Sinclair, a sustainable investment strategist at SinCo, said many local companies had the policies for dealing with investment in the context in climate change. But they had been unevenly implemented.

"The net result is shorter time horizons, and a short-term performance fixation. While the absence of long-term thinking may affect investment-as-usual in general, short-termism is especially the antithesis of sustainable investment," he said.