08 June 2010 #Environment
The nascency of the environmental technology sector has, not surprisingly, resulted in much focus on early stage investments predominantly in the realm of angel, venture capital, and smaller private equity investments, all of whom are looking to make returns in the short to medium term. It is surprising then, that the long term nature of the climate change problem and the necessary paradigm shift in investment has not fully penetrated the world of pension fund investments. By their very nature, and similar to many climate change-related investment opportunities, pension funds must strategise for the long term.
The term ‘fiduciary duty` is one that is very important in the world of investments, especially within the underlying world of pensions. Investors at all levels, including pensions, see the environmental technology sector as a risky proposition due to its novelty, lack of tangible data, knowledge and/or experience. Fiduciary duty therefore requires pension fund trustees to take a cautious approach to allocating assets to the sector.
However, climate change offers opportunity in the form of increased demand for renewable energy production being encouraged via fiscal and regulatory incentives globally. Such policies are making investments in the sector more acceptable. This, in addition to a move towards investment in infrastructure as exposure to listed equities has decreased, is resulting in the first pension players allocating significant proportions towards the sector. One significant example is the Norwegian government pension fund allocating $3.1b to clean technologies through 2013. Such moves, considered pioneering, will go a long way to mitigating the risks associated with novelty, lack of tangible data, knowledge and/or experience.
Fiduciary duty also requires trustees to consider and plan for the broader climate change-related risks faced by the private sector, in which they have significant interests, in the long term. Historically, asset allocation of UK pension funds has been skewed towards listed equities. In 2004, this amounted to an average of 70% of assets. In comparison, according to the latest statistics from Mercer Investment Consulting, in 2009 the average UK pension fund had 50% of assets exposed to the equities market, 41% to the bond markets, 2% to the property market, with the remaining 7% to other asset classes. Though there has been a noticeable decrease in exposure to equities from 2004, the most recent statistics clearly show that on average, there is still significant exposure to equities, and therefore corporations. With pensions looking for stable long term growth, high exposure to the equities markets is a contrary position. Listed equities are tasked to deliver short-term shareholder value, which can be at the expense of long term risk mitigation. Climate change is a pressing long term risk that could be unforeseen in this short term approach of listed companies. Thus, in order to adequately manage risk, a move away from short term profit exposure should be implemented with more exposure to long term investments that account for climate change. In fact, a recent survey by the consultancy bfinance suggests that 54% of pensions plan to decrease allocation to listed equities whilst only 17% plan to increase exposure to the asset class.
In relation to the climate change issue, the resulting insight is that 50% of pension funds` assets are exposed to the same climate change-related risks faced by the corporations in which they have invested. Be it regulatory, physical, competitive, litigation or reputational risk, all have their own unique impact on the private sector as a result of climate change. It is therefore not only in the trustees` interest to mitigate these long term risks, but also their duty to do so. A recent example of the risks investors can face is highlighted by the BP oil spill, which has resulted in a loss of $20 bn market capitalisation at the time of writing.
The wide impact of climate change-related regulatory and fiscal policy on the private sector in addition to increasing stakeholder pressure to use the pensions` position to affect change is likely to create investment opportunities across most asset classes. Specifically, larger infrastructure-type projects such as wind farms provide an investment that will make returns over the long term, protect against market volatility and inflation, and provide a route for diversification away from short term equities.