How The Climate Could Shape Our Investments

The biggest concern around climate change is that it encroaches slowly - slow enough for us to normalise our new normal each year without causing sheer panic. However, one area that usually gets our attention, rather selfishly, is our own well-being and wealth. So, one way to explore climate change can be by looking at how it will shape our investments, highlighting how important it is to educate ourselves on the climate regardless of whether we have charitable intentions.

Physical risks

The most obvious impact that climate is having is on our real world. More unpredictable weather, more droughts, higher temperatures, and other extreme weather events. Some of these damages are economic, with infrastructures being impacted that can be difficult to foresee. However, industry-wise, we can expect one of the biggest impacts to be on agriculture.

Exposure to physical risks may reduce profitability in the face of rising insurance costs. Some property markets may also suffer from these changes as people become less tempted to live in hot, dry environments that pose increasing drought risks. We could even see increasing migration from dry areas on the continent to more humid ones, which introduces even more challenges to the underdeveloped world.

Though, it’s not just temperatures that are an issue. Sandbanks is one of the richest property markets in Europe, yet it might be underwater by 2050.  

Transition and regulatory risks… and Opportunities

There will always be a reaction to these developments. Capital very quickly re-allocates even if labour movements lag behind. Industries will have to take steps to fit with the growing pressure to have a low-carbon footprint, but this will be easier for some industries than others.

One example might be that beef, which is by far the most inefficient use of water per gram of protein created, could be taxed more harshly in order to drive down demand. Perhaps eggs and other cleaner forms of protein would avoid such a tax, meaning that investors need to focus closely on industries that produce negative externalities. Or, the recent discovery of lab-grown meat could become cost-effective enough to replace beef farming.

Short-haul economy plane companies like RyanAir and WizzAir also face growing scepticism. It’s difficult for them to make any adjustments to lower their carbon footprint, yet, train companies can easily be given transitional subsidies to promote train travel for short journeys. France overtly banned short-haul flights recently. Clearly, investors need to seriously consider what the growing pressure to lower carbon emissions will do to the industries they are exposed to. 

This may present opportunities too, of course, as it may be possible to spot trends. Are cars being phased out in favour of electric scooters? Are modular laptops the future because of growing pressure to end landfills being filled with “broken” laptops that have 90% working parts? What if the EU makes it illegal to sell electronic devices where the battery is not removable, who will be in a better position to adapt?

Customer preferences

Whilst this may be an optimistic view, there could be a growing trend towards buying from businesses that brand themselves as being environmentally friendly. Not just greenwashing, but legitimate movements away from using fast fashion brands in favour of apps like Vinted, which sells second-hand clothes.

More and more startups are focusing on renting clothes, subscription-based children's clothes in which you borrow them for only as long as they fit the child, and other solutions that incentivise lowering your own single-use consumption patterns. As these initiatives tap into the more self-serving desires, such as convenience, then demand could follow. In a cost of living crisis, it cannot be expected that customers behave against their own interests.

The movement against cars, as seen by the rapid growth of the “f*ckCars” subreddit”, is coming at a time when new international rail projects are getting the green light, e-scooter hires are seen on most street corners in Europe, and cars are now seen as merely temporary modes of transport. It’s now possible to use cars much like the e-scooters, where they can be rented on a minute-by-minute basis. Such movements bring into question which automobile companies will adapt to these changes in consumer behaviour, where having two or three cars per household may soon be redundant.

Trends towards new forms of revenue

This also highlights a new type of monetisation. Subscription services are a hugely popular way to charge customers now - to which many laugh at the absurd paywalls placed on existing products, like BMW charging monthly fees to unlock the heated seats.

But it may be linked to climate change in many cases. If the focus is on recycling and sharing as opposed to everyone owning their own unique unit, clearly this paves the way for subscription services. Revenue would fall off if firms relied on people continuing their overconsumption habits, so now we need to pay infinite subscriptions to not own the product. This is why tech firms are taking over many industries because they can offer such solutions, connecting people together to share, swap, and rent each other's resources. There’s no need to build a new hotel when local residents are renting out existing spare rooms.

Furthermore, this is a future that is predicted by the World Economic Forum, “You’ll own nothing. And you’ll be happy”, though wrongly described as being their goal rather than a prediction; a reality that many people say they resist. But, one thing that is clear in this vision is the ever-growing necessity of courier services, be it via drones or automated robots. Investors, therefore, need to consider how power may be concentrated towards tech companies that rely on such processes and logistics, whilst simultaneously putting under threat many so-called evergreen industries.

Final Word: Is ESG the answer for equity investors?

Whilst active investors may be chomping at the bit, many passive investors dread the thought of indulging in such predictions and speculated investment decisions. Whilst we hoped ESG would be a great solution to this, simply by outsourcing our ethical assessments to separate agencies in bulk, it turns out that they are unreliable.

Ultimately, whilst the climate may have big implications for stock-picking investors, it doesn’t pose the same concern for index investors who have spread their bets. Good diversification will mean that there is weighted exposure to the small minority of large tech firms offering innovative green solutions. Not to say they will be the greenest solutions, but then profits will never correlate strongly with companies’ positive impact on the world.