The environment and economy, both with the overlay of geopolitics, are the biggest investment challenges but also carry huge opportunities, senior executives told the AIST Superannuation Investment Conference last week.

The pandemic and its fallout, a possible climate catastrophe, decarbonisation and re-industrialisation came up again and again at last week’s ASI, with speaker after speaker proposing how to turn what they say is inevitability into benefit for members.

The event came just weeks after the release of the federal government’s Intergenerational Report, which for the first time forecast the economic implications of climate change and higher temperatures, including the potential decreased output from labour productivity and the impact on crop yields.

Last century was the century of the economy but we are now in the century of the environment, said the conference’s opening speaker, futurist and strategic planning expert Keith Suter.

“During this century, we will need to be able to solve some of the problems that we have created with the economy last century,” Suter said. “You can ignore reality but you cannot ignore the consequences of your ignoring reality.”

But far from being a doom scenario, the environment is redefining the investment landscape, posited Lucian Peppelenbos, climate and biodiversity strategist at Dutch asset manager Robeco, which invests in arguably more climate-rescue-progressed Europe.

“Nature loss and climate change are amplifiers of risk and opportunities precisely because the transition is uneven, it is less linear; there is increasing spreads and increasing volatility in the market,” he said.

To add further difficulty, the situation is challenging traditional investment tools and models.

“Our valuation models, our investment models need to internalize externalities. Carbon pricing, cost abatement curves, demand destruction, exponential adoption rates – those sorts of things need to find their way in our investment goals,” Peppelenbos said.

“Strategic asset allocation needs to incorporate climate change and nature loss scenarios into capital market assumptions.

“We are also running into the limitations of historical data sets and even benchmarks because they are reflective of the economy of the past and not indicative of the changes to come. Now in my company, we call this P.M. 2.0.”

Deflationary decarbonisation

The lens through which portfolio managers view the world has irrevocably altered, agreed Stuart Wrigley, head of alternative capital markets strategy in Asia Pacific at Goldman Sachs Asset Management.

“The way we think about risk has to change from being backward looking to forward looking,” he proposed. “I think in the past, it was very much pattern recognition and very bad.”

It is also flawed to consider geopolitics as “something we can trip over” when we are making investment decisions, he said: “It can actually turn into a tailwind.”

Amid a COVID-induced economic shut down and the Russian invasion of the Ukraine, supply chains and the severe disruption of those are where the battle lines have been drawn, according to Wrigley.

“It’s leading to re-industrialisation and a lot of it’s also impacting the way that our CEOs think about the world,” he says.

The energy transition will – as a result – be swifter, believes Marigold Look, executive director, infrastructure at IFM Investors.

“What is happening is now it’s accelerating the build out of renewables because the sun and the wind are free and you cannot be held hostage from a pricing or supply perspective,” she says.

“So that’s providing us significant opportunities.”

However, Robeco’s Peppelenbos sees growth potential far beyond energy-related industries.

“People immediately think of windmills, solar, batteries, batteries, bees, butterflies and trees – and that’s all true,” he said. “But to be frank, in the public markets, green assets are really limited… of all the listed companies in the world – 45,000 of them – about four are nature positive, that’s 0.01 percent.

He believes there is big opportunity for whole economy to transition, rather than investing in green assets themselves.

“It is industry, it’s transport, it’s food, it’s buildings, it’s all of it,” he said. There’s $3.8 trillion per year needed in investments until 2030. After 2030, even more.”

Portfolio managers need to identify the companies that will enable the transition and champion the transition to the green economy of the future.

“Those are the winners of tomorrow,” he said.

But Peppelenbos also almost spoke of a virtuous circle in terms of the environment.

“We as investors: our role is to really accelerate the transition of those brown industries – rather than facing away from them, we should actually get close to them and really understand those companies and analyse their transition readiness,” he said.

“Rather than using carbon footprints, which are a reflection of the past and would tilt us away from brown industries, we should focus on the transition-readiness of these companies – that’s what should drive our investment decisions.

“For us, one of the sweet spots of investing in Europe is actually investing in those high- emitting industries. We are seeing a correlation between those ‘green’ brown stocks and financial performance.”

But what of inflation in all of this?

Though the impact of the rush to renewables has been inflationary to date, IFM Investors’ Look believes that ultimately de-carbonisation will be deflationary because there will be more supply coming to the market and in terms of capacity and construction.

Robotic pricing power

Across all industries, pricing power in the inflationary environment has been key and those products that have sustained demand regardless have thus far thrived, says Kristian Fok, chief executive of Cbus.

“[These are] the industries that we all know and hear about that have a service or product that is appealing to the masses, where the alternative sources of supply are not readily available, and therefore the cost pass-through is a benefit and it supports pricing,” he says.

“And that goes to utilities; in the current environment, it goes to subsections of global equities; I think there are numerous examples – the question for me is how many of those can sustain that pricing power into the future?”

Because Fok sees a new determinant going forward.

“Anybody who prevails in an AI context is going to have some level of pricing power and will get bigger and stronger,” he said. “That by definition enables some level of resilience.”

Goldman Sachs’ Wrigley agrees the potential from AI, robotics, data science and other forms of automation is enormous.

He foresees big potential from AI for healthcare, in particular, in robots reading radiography reports and, ultimately, the diagnoses of disease.

“I think the biggest impact from AI will come from really where the human is doing the more mundane tasks that the computer can count into and then the human can step back and do more value-add,” he says.

So, a key investment metric for him is also around the ability to adapt: “Can you actually take an old-economy company and implement AI, for example, and really drive transformational change?”

And then there are the opportunities – and one big danger – for super funds themselves.

“The issue for all boards and trustees is that AI needs to be viewed in the context of the enormous risk we have around data privacy [for] members,” said Andrew Fisher, head of investment strategy at Australian Retirement Trust.

“For us internally, there’s a process around putting forward a user case and why you might want to use AI but the threshold at this early stage is very high given the risk.”

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