Climate change is transforming our perception of investment opportunities and risks at a global level, and there is a palpable sense of alarm as we see the real-world, real-time effects of climate change play out before our eyes. Moreover, there is a growing recognition that climate policy needs to be an integral part of action plans at an individual pension plan, state and national level. While previously the goals of capitalism and those of broader society were viewed as somewhat distinct, there is an increasing acceptance that they are inextricably linked as the world undergoes an accelerating pace of change.
High-profile events in the US provide striking examples of how vulnerable communities and corporate balance sheets are to the effects of climate change. For example, 2020 was a record- setting year for wildfires in California, costing over US$12bn in damages. In February 2021, millions were left without power in Texas as the energy grid was overwhelmed by a surge in demand, providing a glimpse of a ‘hellscape’ future if sufficient resilience is not built. Finally, soaring property insurance rates in Florida are tangible evidence of the escalating risks associated with climate change. It seems that the bill for living in a community vulnerable to the effects of sharply rising temperatures is coming due.
Promising steps are being taken: in April 2021, having previously rejoined the Paris Accord, President Biden announced an ambitious plan for the US to cut its greenhouse-gas emissions in half based on 2005 levels, in the latest push by the administration to aggressively combat climate change. While a detailed roadmap is yet to be laid out and some are skeptical about the achievability of the targets, the fact that the US has revived its leadership and ambition in this area will undoubtedly have a positive ‘domino effect’ on other countries’ aspirations. At a state level, the state of Illinois legislature recently enacted a bill that requires most state pensions to develop a climate-change risk minimization policy that considers the financial risk to the investments held by the pension plan in the event of different levels of climate change, as defined by the United Nations Framework Convention on Climate Change.
In a recent CEO letter, Larry Fink of BlackRock highlighted the fact that climate risk equates to investment risk and that climate change is driving a profound reassessment of asset values. Never has this been truer than in recent years when the potent combination of natural disasters, increased scientific knowledge and greater social consciousness, particularly among the younger generation, has heightened awareness of where we are heading.
Our Sustainable Real Return strategy places such considerations center stage and enables pension plans to fulfil their sustainable aspirations and goals through a flexible, dynamic, multi-asset approach. Climate-change assessments permeate all the strategy’s holdings, which represent the broad economy and capital structure; such considerations are critical if we are committed to driving real change across society, and should ultimately serve as a catalyst for change.
Rigorous Climate Modeling
In addition to using external data to break down climate risks, we apply our own cost-of-carbon assumptions which serve as an input in our cash-flow forecasts. Estimating a cost of carbon based on the damage arising from carbon usage tends to result in a prohibitively high value, and we therefore favor a more widely accepted approach. This consists of attributing a theoretical cost, designed to change corporate and consumer behavior and making it economically more viable to go down a less polluting route. Based on this robust modeling, we can then examine the detail of a company’s strategic plans and engage with management to ensure that the direction of travel is positive, including acceptable time frames to deliver change.
A similar rigor is applied to all holdings across the asset-class spectrum, and it is no accident that a number of securities do not adhere to the more stringent criteria applied within our sustainable portfolio and are therefore excluded. For example, a German energy company held in our core Real Return strategy is making solid progress towards a cleaner energy profile but does not currently score sufficiently highly to be included in the Sustainable Real Return strategy which is more stringent in its ESG criteria. At the time of purchase, another energy holding was something of a trailblazer in terms of its transition to clean energy. However, we subsequently sold the position owing to a slower pace of progress than anticipated.
Identifying the Winners
Other holdings are clear winners from a climate-change perspective: renewable energy providers are beneficiaries of the increased investment in clean energy, as are those companies with exposure to the electric-vehicle trend, including a battery manufacturer and a connector and sensor manufacturer. Given the blue-chip nature of the strategy’s equity portfolio, disclosure levels and transparency are generally high, enabling us to clearly track a company’s sustainable profile and assign a proprietary rating.
While the strategy has exposure to gold, favored as an effective store of value in times of stress and for its inflation-hedging properties, we have chosen to avoid the gold miners themselves. From an environmental perspective, gold mining gives rise to many issues. The destruction of habitats, the massive energy and water required for its extraction, and milling and the use of cyanide to leach gold from the ore all contribute to the destruction of the planet. Moreover, there are often social and governance issues including human-rights abuses and corruption. In contrast, there are many attractive ESG aspects associated with physical gold, including the minimal energy required for storage, the fact that it is always recycled and that annual mining production is immaterial. All the gold holdings in the Sustainable Real Return strategy are checked for their compliance with the ‘Responsible Sourcing’ program of the London Bullion Market Association.
Experience and Pedigree
Like many aspects of ESG, climate-change considerations can be nuanced and it is here that the experience and pedigree of the team comes into play. Newton has strong foundations in responsible investment, dating back to its foundation in 1978, and has been conducting ESG reviews on recommended securities for over 15 years. The discipline applied to the Sustainable Real Return portfolio is common to our full suite of sustainable strategies and, although the time horizon may be somewhat longer-term in nature versus our core strategies, we do not believe that there is a need to sacrifice investment returns. The associated benefit of contributing to or, at the very least, not detracting from better long term outcomes for society and the environment should surely be one that resonates among pension plans with a long-term time horizon, and is worth considering in the context of an overall investment portfolio structure and make-up.
Newton Sustainable Real Return Strategy – Key Investment Risks
- Performance Aim Risk: The performance aim is not a guarantee, may not be achieved and a capital loss may occur. Strategies which have a higher performance aim generally take more risk to achieve this and so have a greater potential for returns to vary significantly.
- Currency Risk: This strategy invests in international markets which means it is exposed to changes in currency rates which could affect the value of the strategy
- Derivatives Risk: Derivatives are highly sensitive to changes in the value of the asset from which their value is derived. A small movement in the value of the underlying asset can cause a large movement in the value of the derivative. This can increase the sizes of losses and gains, causing the value of your investment to fluctuate. When using derivatives, the strategy can lose significantly more than the amount it has invested in derivatives.
- Changes in Interest Rates & Inflation Risk: Investments in bonds/money market securities are affected by interest rates and inflation trends which may negatively affect the value of the strategy.
- Credit Ratings and Unrated Securities Risk: Bonds with a low credit rating or unrated bonds have a greater risk of default. These investments may negatively affect the value of the strategy.
- Credit Risk: The issuer of a security held by the strategy may not pay income or repay capital to the strategy when due.
- Emerging Markets Risk: Emerging Markets have additional risks due to less-developed market practices.
- Shanghai-Hong Kong Stock Connect and/or the Shenzhen-Hong Kong Stock Connect (‘Stock Connect’) risk: The strategy may invest in China A shares through Stock Connect programs. These may be subject to regulatory changes and quota limitations. An operational constraint such as a suspension in trading could negatively affect the strategy’s ability to achieve its investment objective.
- CoCos Risk: Contingent Convertible Securities (CoCos) convert from debt to equity when the issuer’s capital drops below a pre-defined level. This may result in the security converting into equities at a discounted share price, the value of the security being written down, temporarily or permanently, and/or coupon payments ceasing or being deferred.
- Investment in Infrastructure Companies Risk: The value of investments in Infrastructure Companies may be negatively impacted by changes in the regulatory, economic or political environment in which they operate.
- Counterparty Risk: The insolvency of any institutions providing services such as custody of assets or acting as a counterparty to derivatives or other contractual arrangements, may expose the strategy to financial loss.
- Sustainable Strategies Risk: The strategy follows a sustainable investment approach, which may cause it to perform differently than strategies that have a similar objective but which do not integrate sustainable investment criteria when selecting securities. The strategy will not engage in stock lending activities and, therefore, may forego any additional returns that may be produced through such activities.
Your capital may be at risk. The value of investments and the income from them can fall as well as rise and investors may not get back the original amount invested.
This is a financial promotion. This document is for institutional investors only. Material in this publication is for general information only. The opinions expressed in this document are those of Newton and should not be construed as investment advice or recommendations for any purchase or sale of any specific security or commodity. Any reference to a specific security, country or sector should not be construed as a recommendation to buy or sell investments in those countries or sectors. Please note that strategy holdings and positioning are subject to change without notice. Newton research performs ESG quality reviews on equity securities prior to their addition to Newton's research recommended list (RRL). ESG quality reviews are not performed for all fixed-income securities. The portfolio managers may purchase equity securities that are not included on the RRL and which do not have ESG quality reviews. Issued by Newton Investment Management Limited, The Bank of New York Mellon Centre, 160 Queen Victoria Street, London, EC4V 4LA. Registered in England No. 01371973. Newton Investment Management is authorized and regulated by the Financial Conduct Authority, 12 Endeavour Square, London, E20 1JN and is a subsidiary of The Bank of New York Mellon Corporation. 'Newton' and/or 'Newton Investment Management' brand refers to Newton Investment Management Limited. Newton is registered with the SEC as an investment adviser under the Investment Advisers Act of 1940. Newton's investment business is described in Form ADV, Part 1 and 2, which can be obtained from the SEC.gov website or obtained upon request. Personnel of certain of our BNY Mellon affiliates may act as: (i) registered representatives of BNY Mellon Securities Corporation (in its capacity as a registered broker-dealer) to offer securities, (ii) officers of the Bank of New York Mellon (a New York chartered bank) to offer bank-maintained collective investment funds, and (iii) Associated Persons of BNY Mellon Securities Corporation (in its capacity as a registered investment adviser) to offer separately managed accounts managed by BNY Mellon Investment Management firms, including Newton. Certain information contained herein is based on outside sources believed to be reliable, but their accuracy is not guaranteed. Unless you are notified to the contrary, the products and services mentioned are not insured by the FDIC (or by any governmental entity) and are not guaranteed by or obligations of The Bank of New York or any of its affiliates. The Bank of New York assumes no responsibility for the accuracy or completeness of the above data and disclaims all expressed or implied warranties in connection therewith. © 2021 The Bank of New York Company, Inc. All rights reserved. In Canada, Newton Investment Management Limited is availing itself of the International Adviser Exemption (IAE) in the following Provinces: Alberta, British Columbia, Ontario and Quebec and the foreign commodity trading advisor exemption in Ontario. The IAE is in compliance with National Instrument 31-103, Registration Requirements, Exemptions and Ongoing Registrant Obligations.