The scientific consensus is in: climate change is occurring and getting worse. Climate change encompasses global warming, increased presence of droughts, rising sea levels, melting ice caps and poor air quality, among many other factors. Indirectly, this poses a risk to investors that they may not even realize.
Given how lucrative oil companies are, many investors construct their portfolios with direct exposure to energy companies. The world’s largest oil companies are also the some of the world’s largest companies, which attract investors with generous buyback and dividend programs. That said, as regulations aimed at preventing climate change are more strictly enforced this may infringe on energy company’s earnings.
Unfortunately, since the urgency to act is not immediate, investors haven’t felt the need to adapt their investment strategies
Regulatory changes are the biggest threat to many investors whose portfolios are exposed to the oil and gas industry. As regulations aimed at punishing big emitters become more abundant, this will put a drag on the returns of companies in those industries. Investors currently face a stark choice, they can either make proactive changes to their holdings today or they can face substantial losses across their entire portfolio should robust regulatory action take place.
Environmentally-friendly portfolios do not mean that every investment has to be focused on clean energy or energy efficiency. A common strategy is to look for companies in traditional strategies that take climate change into account in their normal business operations. Alphabet (GOOGL) is a prime example since its core business is web search; however the company continues to make energy efficient investments such as its acquisition of Nest Labs.
At the pace climate change is moving, investors are primed to lose $4.2 trillion by 2100 even if global warming is held at +2oC. If investors tilt their portfolios from polluters to those that try to reduce them, they may be able to hedge against the downside effects of climate change. Unfortunately, since climate change is viewed as a long-term problem, investors have gravitated to increasing returns in the near term rather than saving the planet in the long run.
In an ideal world, regulations and taxes would cripple the oil and gas industry, forcing everyone to transition to clean energy. Investors with environmentally harmful companies in their portfolios would lose out, but the world would be a cleaner place. Unfortunately this is a distant scenario given oil’s influence on every part of the economy.
Currently, oil and gas operate in a multi trillion dollar market and is an input into products from automobiles to consumer staples. An aggressive tax would put a drag on returns and a subsequently larger one on the whole economy. As oil prices rise in response to stringent regulations, demand for automobiles would fall. Investors would feel this in almost every aspect of their portfolio when earnings of large companies start to fall.
Contrary to popular belief, clean investments do not always sacrifice a high ROI for social responsibility. In the past few years the alternative energy sector has performed remarkably well, whether it's single companies or Green ETFs. Even financial technology has caught up to this trend. Motif Investing currently offers a climate change motif which consists of 25 weighted stocks designed to take advantage of clean energy. Although the thematic investment has underperformed, the investment is intended to act as a long term trend rather than a quick trade. This past year, clean energy reached a record $329 billion in investments.
It's no longer a debate whether climate change is occurring, now it is just a matter of how fast it will erode our way of life. Despite this well-known fact, investors have failed to prepare their portfolio for the inevitable. Clearly the world economy cannot go cold turkey on non-renewable energy, but committing to replace traditional energy companies with renewables is a good first step.