As the Reserve Bank of Australia warns of the financial impact of climate change, Australian retail investors are following the lead of their institutional counterparts by turning to more sustainable investing.

Australia’s central bank recently examined several concerns about the resilience of the global economy in its Financial Stability Review released earlier this month, describing climate change as a “considerable risk” to the financial system.

“Climate change is exposing financial institutions, and the financial system more broadly, to risks that will rise over time and, if not addressed, could become considerable. These risks for financial stability may arise from both the physical and transition risks of climate change,” the Reserve Bank of Australia (RBA) said.

“Addressing these early will help to both mitigate the transition risks and reduce the scale of the challenge that physical risk poses to financial stability in future,” the RBA said.

More than 60 central banks, including the RBA and the Bank of England, have warned that global GDP could fall 25 per cent below the expected level by 2100 if the world neglects efforts to reduce global greenhouse gas emissions.

This estimate is included in scenarios published earlier this year by the Network for Greening the Financial System (NGFS), a collection of 66 central banks and supervisors and 13 observer institutions.  However, that estimate is conservative, and does not account for all sources of risk, including low probability high-impact events, sea level rise, extreme events and societal changes such as migration and conflict, the NGFS said a June 2020 report.

And some economies will be worse hit than others, says Rick Stathers, a climate specialist at Aviva Investors.

“Recent research from Oxford Economics and from McKinsey highlight this uneven impact, with tropical regions likely to be impacted the most by the physical impacts of the climate breakdown,” Stathers says. “Indeed, Oxford Economics reports that some countries like India and Nigeria could see 90 per cent of GDP impacted by 2100. 

“Suffice to say, the impacts will vary around the world and will be influenced by numerous factors such as the underlying nature of the economy, for example, agriculture vs industrialised, the ability of a nation to invest in resilience, the local geography as well as global location.

“For example,  Bangladesh will be impacted by sea level rise, whereas Switzerland by the loss of skiing tourism. Though it will be the countries that have contributed the least to causing climate breakdown that will be impacted the most.”

Backing the cause

While superannuation funds seeks to combat climate change by engaging with companies and via their voting power, retail investors too are increasingly aware of climate risk and are putting their dollars behind their values.

“Retail investors are increasingly aware of environmental, social and governance (ESG) and sustainability risks around the transition to a low-carbon economy,” says Grant Kennaway, director, manager research with Morningstar.

“You can evidence this from fund flows into the retail sustainable fund sector,” he says. At the end of the second quarter of 2020, Morningstar estimates that Australian retail assets invested in sustainable investments amounted to $19.9 billion, a 21 per cent increase compared with 30 June 2019. Following the volatility in the first quarter, estimated net flows to sustainable funds were muted in the second quarter but still positive at $335 million.

“Investment options and assets in sustainable funds in the Australian retail marketplace continue to grow, with promising signs of performance during the volatility caused by the pandemic,” says Kennaway in a report, Sustainable Investing Landscape for Australian Fund Investors, co-authored with Morningstar analyst Peter Gee.

The Morningstar report notes a small but increasing number of managed funds with an environmental theme, with renewable energy and water-focused funds being the most prevalent.

However, if Australians want to avoid exposure to fossil fuels, “they need better regulated portfolio holdings data (what stocks a fund holds) to provide the transparency they deserve,” say Kennaway and Gee.

While the sustainable fund market is still relatively small in Australia, Kennaway and Gee have identified 10 additional funds that have been launched in the year to 31 August through Morningstar's sustainable attribute framework, bringing the total number of individual sustainable strategies available to Australasian retail investors to 108.

Emma Pringle, head of ESG at Maple-Brown Abbott, says retail investors are often aware of the physical impacts of climate change—evident, for example, during the elevated level of interest witnessed during the Australian bushfires last summer, whereas “institutional investors focus on a range of risks including transition risks and also keep abreast of policy, liability and reputational risks to minimise any value erosion from climate risk.”

Aviva’s Stathers also expects greater retail interest in environmental investing. “Retail investors may have less push factors (regulations, stakeholder consultation) for them to consider climate risks in their investing activities than institutional investors.  At present it would appear institutional money is integrating this more, but I would imagine retail investors aren’t far behind in connecting the impact their investments have on climate and vice versa.”

Masja Zandbergen, head of sustainability integration with global fund manager Robeco, also notes that institutional investors have a long-term investment horizon, and so are likely more aware of climate risk. “It is our fiduciary responsibility to inform clients, also retail investors, about ESG risks in general and climate risk in particular,” Zandbergen says.

Costs—and opportunities

Guillaume Mascotto, head of ESG and investment stewardship with American Century Investments, says his firm has identified the following sectors as most exposed to potential climate change risks:

  • oil and gas
  • mining
  • forestry
  • construction
  • real estate, especially near coastlines
  • banks and insurers
  • power and utilities
  • agriculture
  • transport

Asset managers will need to show how they assess and integrate the impacts of climate change, including physical risks and those arising from the transition risks of shifting to a low-carbon economy, in their investment processes, Mascotto says.

“However, our framework also identifies opportunities flowing from climate change for companies involved in these sectors, notably in the realm of EVs, power storage, biodiesel, wood-based construction, fibre-based composites, and biochemical applications, smart grids, renewables, digitalisation.”

The chief executive and senior portfolio manager, Max Cappetta of Redpoint Investment Management, also cites opportunities. “Electricity production is shifting towards decarbonised and renewable means, which will support companies involved in activities related to power generation via solar and wind for example,” he says. 

“Finding ways to manufacture key building inputs such as cement, steel and aluminium in a less carbon-intensive way is also critical,” says Cappetta.

“Those companies that can modify their activities to be less carbon-intensive are expected to benefit most versus those that do not or cannot. Looking deeper into supply chains, there is scope for transportation to evolve away from being fossil-fuel based to electric power.” 

One notable example is Honda, which is moving to produce electric cars only. The company recently announced it will end very successful partnerships with the Red Bull Formula One (F1) and Scuderia AlphaTauri racing teams at the end of 2021, as it targets “carbon neutrality by 2050”.

Instead, Honda will funnel its corporate resources in research and development into environmentally friendly technologies, including fuel cell vehicle (FCV) and battery EV (BEV) technologies, “which will be the core of carbon-free technologies.”

“As the automobile industry undergoes a once-in-one-hundred-years period of great transformation, Honda has decided to strive for the ‘realisation of carbon neutrality by 2050.’ This goal will be pursued as part of Honda’s environmental initiatives which is one of the top priorities of Honda as a mobility manufacturer.”