Despite its hugely progressive, efficient and vastly wealth creating characteristics, the modern capitalist model seems to struggle to deal effectively with externalities such as greenhouse gas “GHG” driven pollution. These emissions are contributing to an unprecedented heating of the planet. Today we are at around 1.1 degrees Celsius above the 1900 baseline normal temperature1. This is not something to be taken lightly. By the year 2100, if we continue on the current GHG emissions path, we are projected to reach a +4 to +5 degrees Celsius consistent warming level above the baseline2. Last time we had a consistent five degree increase was about 250 million years ago and 96% of living species became extinct3, hence needless to say our trajectory is not on a good path as things are changing (for the worse) quicker than scientists were forecasting. This is important in the world of real assets as the building sector alone (including construction and operations) contributes c.40% of anthropogenic global carbon emissions4. Hence, remaining passive in the face of this collective challenge may be something that future generations may not quickly forgive us for.
Avoiding the Problem vs Addressing the Problem – why passive won’t do.
Whilst investing in ETFs can have upsides in theory, mainly as it relates to the cost, it ends up making the climate problem a lot worse as due to the investment size some ETF hold in certain stocks without informed engaging. This leads to their passive support of managements’ default strategies, and may mean changes to environmental policies are more difficult to bring on-board. Also for a passive index tracker to have a dialogue with a company, comes from a place with fewer degrees of freedom for the passive investor. Passive index allocators often end up exacerbating the issue and make it more difficult to make these very real changes that are necessary to progress towards the common goal, via market practices. A recent innovation from the passive community has been to offer ESG ETFs, where a certain industry will be excluded. Exclusion – whilst positive in terms of signalling and with-holding capital, is not engaging with the company. Given the choice of avoiding vs addressing the problem, our Real Active approach chooses for the latter.
What are we doing about it?
At the Real Assets team we scrutinize management teams and their sustainability goals to make sure that there is a climate policy in place and a proper decarbonization strategy. We are experts at seeing right through “green-washing” as we have been integrating environmental performance since inception (2011), and never as an afterthought added to the investment process at a later stage. In essence, we are first movers in this space and we pride ourselves greatly on that. Since February of this year all front office staff at the Real Assets team, in combination with our ESG departments, have launched sector-wide engagements where we approach all companies in a real assets cluster with a framework on the tangible actions that need to be taken as a group – given a systemic issue requires a holistic approach. Initial feedback on the sector wide engagement has been very positive with several companies being quick to take notes and consider implementations sooner than later, and recognising us as partners.
Climate change costs priced in our models
Going forward, we expect the impact of climate risk mitigation and adaptation to increase. With respect to mitigation, companies will have to comply with the Paris Agreement and an increasing amount of data and mandatory reporting should become available to measure progress. In the area of adaptation we see an increasing number of research studies focus on where climate risk presents itself. However, climate risk is not binary. We believe focus should be on the costs to adapt for climate risk. These costs should be incorporated into real estate valuations as we do. In our investment process we believe our estimates for climate risk adaptation will become increasingly accurate. In doing so have sought partnerships with a re-insurance company which allow us a rich data source in natural disaster probabilities, which we then mix in our property scores to be able to project necessary predictive capex right down to the building level. It also allows us to lead more focused an fruitful conversations when we meet with management to gage progress and assess various high impact risks ahead.
Active in real assets means being part of the solution
ESG is an essential component in our investment approach. It determines 25% of our company score, and as previously mentioned, we fully integrate it and price it into the valuation models to systematically reward or punish the valuations of real assets companies. This means that we can invest in a company which at a given point in time isn’t doing too well, but has plans to improve, because we would expect that the stock will re-rate as the company invests in the right initiatives. Aversely, if we judge that an ESG compliant stock is fully priced then there might be times where we don’t own it because although the company is doing well, the price might be well above that. Hence the key is on pricing it, and using our engagements as a driver for change, which then would cause for a rerating and be one of our alpha-contributing factors. This is another example of why we call this approach “alpha by control”. It also helps illustrate why we truly believe that investors really do not have the luxury to remain passive in light of the high probability/high impact events ahead of us.
Kempen Capital Management N.V. (KCM) is licensed as a manager of various UCITS and AIFs and authorised to provide investment services and as such is subject to supervision by the Netherlands Authority for the Financial Markets. This document is for information purposes only and provides insufficient information for an investment decision. This document does not contain investment advice, no investment recommendation, no research, or an invitation to buy or sell any financial instruments, and should not be interpreted as such. The opinions expressed in this document are our opinions and views as of such date only. These may be subject to change at any given time, without prior notice.
Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested. Past performance provides no guarantee for the future.