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How investors can play a key role in the global transition to a net-zero future

Heat waves in cities across North America and Europe; raging wildfires in California and the Mediterranean; deadly floods in parts of Australia, China and India. Such extreme climate events have become more common in recent years, yet the road to net-zero carbon emission is now more challenging than ever. 

The World Meteorological Organization said in a report published in May that there is a 50-per-cent chance that the increase in average global temperature would temporarily cross 1.5 deg C above pre-industrial level in the next five years. This is a critical threshold beyond which the effects of global warming will become increasingly harmful for the planet.  

But mitigating the effects of climate change is a challenge that will take decades, not years. It will require massive investments to transform economies, including switching to renewable energy sources, increasing recycling capacity, as well as funding smart energy infrastructure and new technology. 

Investors can play an important role in supporting global efforts to fight climate change and reduce carbon emissions. 

“Investors have the ability to direct capital to those businesses whose operating models are adapting to a net-zero future economy. Through analysis and engagement, investing in climate leaders could both help generate sustainable investment performance but also contribute to reducing carbon emissions and the fight against rising global temperatures,” says Mr Chris Iggo, Chief Investment Officer of AXA IM Core, AXA Investment Managers .

“A low carbon economy in the future will reduce the social and economic risks of climate change and investors can, today, finance the transition to that low carbon future,” Mr Iggo adds. 

Sustainability: A key investment theme

There is now greater urgency for action against global warming. The United Nation’s Intergovernmental Panel on Climate Change, in its latest climate assessment released in April 2022, said keeping to the heating threshold of 1.5 deg C will be impossible without “immediate and deep emissions reductions across all sectors”. 

An increasing number of governments and private companies around the world have pledged to cut carbon emissions. At the global climate change forum, COP26, in Glasgow in November 2021, world leaders affirmed their intention to accelerate action on climate change this decade and work towards targets set out in the ambitious 2015 Paris accord.

Yet Russia’s invasion of Ukraine is threatening the global transition away from fossil fuels, a major source of carbon emissions. Sanctions against the Russian economy, including its energy industry, could lead some countries to burn more coal as an alternative.

It remains to be seen the impact a switch to dirtier fuels would have on global climate targets. Nevertheless, AXA Investment Managers (AXA IM) hopes that the crisis will help to accelerate the use of renewable energy in the long run, because a more sustainable future is important for long-term economic growth and financial returns. 

As the world transitions to a low-carbon future, the following themes identified by AXA IM Investment Institute could offer long-term investment opportunities:

·      Renewable energy: This includes electrification of the transport sector, heating in residential homes, and some industrial processes. Alternative fuels such as hydrogen are also an exciting field to watch;
·      Smart energy: This involves building better digital and physical infrastructure to boost clean energy capacity;
·      Transport: There are opportunities to support the growing electric vehicles sector including increasing charging infrastructure, and supply of batteries and chips;
·      Agriculture: A more sustainable future may drive growth in vertical farming, lab-grown meats and plant-based foods; and
·      Recycling: Reducing waste and reusing materials are set to become more mainstream as businesses and households focus on becoming more sustainable. 

Financing is one of the missing pieces in achieving net-zero carbon emissions. And investors have plenty of opportunities to close the gap.

The International Energy Agency, in its 2021 World Energy Outlook, estimated that an additional US$4 trillion in annual investment is needed by 2030 to keep global warming within 1.5 deg C. 

Investors should keep in mind that all investments carry risks. So it is important to understand the risk-reward trade off involved and ensure that any decisions made are aligned with their risk appetites, investment horizon and financial goals.  

Building a resilient portfolio in the long term 

The global economy faces a myriad of uncertainties from accelerating inflation, tightening monetary policies and geopolitical risks. As a result, the International Monetary Fund cut its global economic growth forecast for 2022 to 3.2 per cent from its previous estimate of 3.6 per cent. This also represents a slowdown from 2021’s growth of 6.1 per cent. 

Weaker economic prospects have rocked financial markets. Some investors and central bank officials have started to warn of a potential economic recession. Clouding the global outlook further, the world’s largest economy – the US  has entered a technical recession after its economy shrinks for the second consecutive quarter in the second quarter of 2022. These near-term uncertainties highlight the importance of having a resilient investment portfolio. 

With greater momentum towards cutting carbon emissions, portfolios that are aligned with this megatrend could be better protected against uncertainties in the long run. At the same time, investors can contribute towards a stronger and more sustainable economy. 

Conversely, investors should be aware of potential risks associated with investing in companies with a bad environmental or social footprint. These companies could face higher taxes as governments work towards their emissions target. Consumers, more mindful about the environmental impact of their purchases, could stay away from products and services by such companies.

As a result, these companies could have higher business costs and reduced profitability, which would then hit investor returns. 

Ultimately, there is a greater imperative for investors to gain a deeper understanding of the entities that they invest in. This includes asking questions about business models, evaluating risks these entities face, and knowing their ESG (environmental, social and governance) impact. Doing this will help investors to build a more sustainable and resilient portfolio.     

“Being a responsible investor is about achieving financial returns without doing harm to the environment and to society. Through in-depth ESG research investors can limit the risk to their portfolios. Through focusing on impact as well as financial returns, investors can direct capital to companies that contribute to better environmental and social outcomes,” says Mr Iggo. 

“Financial returns could be stronger from investments that put sustainability at the heart of the investment process.”