Published: 8.30 CET
Van Lanschot Kempen seeks out opportunities to reduce carbon risk in clients’ portfolios and to invest in the transition to a sustainable economy.
Applying an appropriate sustainable benchmark for a global equity portfolio could lower the carbon-transition price risk by 70-80% for global equities and by 90% for European equities.
The sensitivity of equity markets to carbon pricing risk has increased over the past 12 months due to rising energy prices and geopolitical tensions. Van Lanschot Kempen has updated its model on the impact of a shock increase in carbon prices globally - implemented through a carbon tax or through emissions trading scheme (ETS). The analysis focuses on how responses to climate change can be integrated into investment analysis in order to protect and enhance the portfolios of long-term investors.
Van Lanschot Kempen’s analysis models a worst-case scenario but expects the impact to be spread over a number of years.
Maarten Edixhoven, Chair of the Management Board of Van Lanschot Kempen, said. “The current energy crisis has raised concerns that meeting global climate goals has become less urgent. However, nature is telling us that it is still a high priority by the number of huge environmental impacts we are seeing. We think the focus on reducing carbon emissions will – and should - only get stronger in the medium term.
“As an entrepreneurial wealth manager with a strong focus on sustainability we aim to act as a guide to our clients in the current climate and energy transition. Reducing the carbon-transition risk in clients’ portfolios is essential in this respect. Also, we are seeking out opportunities to invest in the transition to a sustainable economy, in both investment and non-investment related services to our clients. We’ve reallocated to lower carbon or climate transition tilted assets and we’re investing in green technologies in both private and public markets.”
Current carbon price must rise to meet Paris objectives and geopolitical energy security risks
The war in Ukraine and Europe’s urgent need to reduce reliance on Russian gas imports have accelerated the need to provide affordable financing for green energy solutions. At COP27, the IMF called for a $75/ton carbon price2, but several institutions, such as the Intergovernmental Panel on Climate Change (IPCC) and the Network for Greening the Financial System (NGFS), now estimate that a carbon price of more than $100 would be required to achieve the Paris Climate Agreement3. According to the World Bank, just 23% of global greenhouse gas emissions are covered by a carbon pricing mechanism4. The IMF estimates that the global average carbon emission price is currently no more than $5 (per tCO2e)5.
It is likely that even a $100 rise in the global average carbon price will not be sufficient to meet the Paris targets. Van Lanschot Kempen’s secondary shock analysis of an increase of $150 per tCO2e highlights that with a higher carbon price level - which accelerates beyond the Paris goals - equity prices could fall more significantly over time. Van Lanschot Kempen believes a rise of $150 is necessary in developed countries to achieve the Paris climate goals. Current pledges by governments appear to be insufficient to reach targets.
A price rise of $150 per tCO2e on polluting companies’ Scope 1 and 2 emissions could knock an average of 9% off global equities and 13% off European equities. If the tax were applied to company’s Scope 1, 2 and 3 emissions, the hit could average -43% for global equities and -44% for European equities. Again, the impact varies by market, but sustainable indices remain considerably better protected against climate transition shocks; falling 6 to 9% for sustainable global equity indices and 4% for European sustainable equivalents, as illustrated above.
Michel Iglesias del Sol, Chief Investment Strategist, and Arif Saad, Co-Head Investment Strategy UK added: “Our analysis shows that the sensitivity of equity markets for higher carbon prices has increased over the past year, despite Covid-19 putting a pause on international travel and more companies announcing climate commitments. We need higher carbon prices to have a chance at significantly reducing emissions. However, the greater the increase, the greater the impact on equity valuations.
“Our research suggests that the costs and benefits of decarbonisation are still not yet fully priced into equity markets. Long term asset owners - such as pension schemes - should reposition equity portfolios to make them more robust to deal with changes in carbon pricing and regulation. This could mean reallocating away from standard indices or tracking alternative sustainable benchmarks. As the analysis suggests, an ESG leader or transition pathway index will be better protected against the risks of higher carbon tax
Careful construction of investment portfolios can substantially limit climate risks
The analysis shows that selection of an appropriate sustainable benchmark for a global equity portfolio can lower the carbon price risk by 70-80%. For a European equity portfolio, this risk could be reduced by 90%.
The Van Lanschot Kempen analysis demonstrates how responses to climate change can be integrated into investment analysis to protect and enhance the portfolios of long-term investors. This could be achieved by a combination of reducing the climate-transition risk from existing equity holdings and – for example - reallocating existing equities to lower carbon or climate transition tilted equities. Another example of an opportunity to benefit directly from the transition economy is investing in green technologies, through new focused allocations across both public and private markets.
Thematic strategies - focusing on clean energy, clean water, food supply and sustainable farmland - are key long-term allocations that should benefit from the climate transition and mitigate physical climate risks, alongside satellite opportunities within infrastructure (listed and unlisted) and impact-focused private equity strategies focusing on disruptive technologies.
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