Rising global population and increased resource scarcity have gradually become more interlinked with climate change and the combination of these issues may generate disastrous consequences. Concerns are mounting over humanity’s environmental impact and fears are growing that we may not be able to feed ourselves in the not too distant future.
The global population has reached the 7bn milestone and over the next 40 years is predicted to rise by one third to 9bn, with most of that growth primarily in emerging markets, according to the United Nations.
Accelerating economic growth in developing countries, combined with rapid urbanisation, means 70 per cent of these consumers will live in cities, and demand more meat, dairy and processed foods, according to a study from fund house F&C. But a changing climate and higher oil prices are interfering with farmers’ ability to meet this growing demand, leading to food shortages and high prices.
“Increasingly, climate change is being seen less as a standalone issue and more as a threat multiplier, as it is overlaid on existing resource stress and is going to make the increasing demand for resources even more difficult to meet,” says Vicki Bakhshi, associate director, Governance & Sustainable Investment, at F&C.
Pressure on natural resources will reach breaking point. Water demand will increase by 40 per cent by 2030, according to the Water Resources Group, energy demand is set to swell by one third by 2035, according to the International Energy Agency and food demand will grow by 70 per cent by 2050, according to estimates by the World Bank and the UN.
These considerations greatly impact the investment decisions of asset managers, which increasingly use extra-financial information such as environmental, social, and governance (ESG) issues in their investment process in order to assess the real risk-adjusted returns of the stocks they invest in.
“Companies that are now recognising what might be the challenges of the next 10 to 20 years for their business and developing plans for that, will be better positioned to respond to these challenges and will have a more efficient business model,” says Richard Stathers, head of responsible investment at Schroder Investment Management. “In theory you should see their valuations being at a premium compared to others that continue to be inefficient and polluting, for example.”
However, although disclosure standards are improving, lack of information, even for European companies, and lack of homogeneity in the metrics used by firms to calculate that information, can inhibit the integration process, he says.
Moreover, often it is not possible to quantify the impact of ESG issues into valuation or stock selection, and the analyst has to make a qualitative assessment of the effect of individual factors, such as how a company manages the environmental impact or treats the workforce, or the impact of poor risk management, and decide whether that company should be at a premium or discount versus other companies.
One notable exception is the impact of carbon emission on climate change. Thanks to the emission trading scheme, which the EU was the first to launch in 2005, it is possible to assign a cost to the carbon a company emits, which can be integrated into the operational cost of running that firm.
Regulation and government action are perceived to be very important in supporting the growth of a more resource-efficient economy.
“We are dealing with huge environmental externalities and market failures,” says Christoph Butz, head of SRI investments at Pictet & Cie, “and it is obvious that a solution will necessitate adequate political responses in order to internalise negative environmental effects into prices of products and services.”
Without the right regulatory signal, polluters will continue to pollute and offload negative effects upon the wider society, whereas those companies that behave responsibly will not be able to reap the fruits of their endeavours, at least not on markets, he argues. “Government action and regulation remain crucial for setting the right incentives for the whole economy to become more resource-efficient. Then more efficient companies will inevitably prevail.”
If energy and other natural resources will be traded at their ‘true’ all-inclusive prices, then markets will take up environment-related technologies automatically and at a much faster pace, says Mr Butz. “But the system changes slowly, and often vested interests stand in the way. Past investments often ‘cement’ structures that are rarely the most efficient in terms of energy or resources use for the future. The incumbent economic actors that stand to lose most from a regime that might leave them less well-off have understandably little incentive to change the status quo.”
Challenges in implementing the right incentives are many. The biggest problem is that we live in an economically globalised world, but our environmental, social and governance standards are still subject to local legislation, says Mr Butz.
“If we cannot agree on a set of internationally accepted standards, then some countries will undermine the process by undercutting these standards and profiting from a relative cost advantage,” he adds.
