Long-Term Matters: It’s the water, stupid
I predict that water will become the single most important physical commodity-based asset class, dwarfing oil, copper, agricultural commodities and precious metals.
Actually, I’m quoting Citi’s chief cconomist, Willem Buiter. And he’s not alone. McKinsey has just published a ‘must read’ 20-page report on the coming eco-resources crunch*.
But there were early warnings about the sub-prime crisis too. So will these new warnings mean investors act? Sadly, no. The eco-crunch just isn’t part of the ‘day job’, at least for mainstream investment professionals. Indeed, the McKinsey report mentions “investors” only six times, even though a lack of capital is the key challenge. Why? Because these opportunities are “not attractive to private-sector investors”.
The dangerous reality - think Durban - is that politicians, lobbied by special interests, won’t force markets to internalise costs related to eco-resource scarcity. Lord Stern says that climate change is “the biggest market failure ever” but the principle applies more generally. And so most market players operate as if clean water, carbon-free air, and so on have no price.
But there will be exceptions here. Several fund managers offer environmental thematic funds. This suits the retail/high net worth market, even if the sustainability credentials of a vanilla thematic fund are questionable. But these vehicles do not connect with the needs of large, well-governed institutional investors that are innovating in different ways.
APG, ATP and several university endowment funds have taken a bullish approach to investing in forestry. As a well-informed client, often working with investment managers who are climate change sceptics, ATP actively compensates for the failure of markets to price in some climate change impacts. Others are focusing on farmland, which gives them exposure to ‘virtual water’ and rising food prices.
Other funds are backing the Climate Bond Initiative which seeks to ensure mainstream investors have the confidence to finance a rapid transition to a low-carbon economy. The initiative has recently won the backing of several major insurance companies.
While these green shoots are encouraging, investors could and should be doing much more.
First, they should be lobbying governments for a supportive environment for dealing with the issues that McKinsey cover pretty well. The key to success is much more professionalism and assertiveness, as the Australian IGCC has shown is possible. As a prerequisite, investors should develop a credible policy ‘wish-list’ which can be used around the world. High on this agenda should be a recommendation that subsidies for fossil fuel are cut back so they are on par with those for renewable energy. Even the IEA has acknowledged how the current subsidy regime is encouraging energy waste and blocking the shift to a low-carbon economy
Second, they should ensure that their own investment supply chains are well informed about the investment implications of the eco-crunch. The most important links are also the weakest - namely the sell-side and credit rating agencies. With PRI boasting $30trn in assets, it is outrageous that there has been so little progress on this front. It is possible, as the Enhanced Analytics Initiative showed, to trigger a shift in the research supply chain, to re-design the project to take account of the new circumstances but the essential first step is for the boards of PRI (and ICGN) to show much greater authenticity and leadership about the gap between what mainstream research suppliers can do and what they are doing today.
Third, investors should support system engagement projects that address the huge challenges that come with the financialisation of the right to life - ie, access to water, food, air and so on. Buiter himself acknowledges these big risks: “I hope and expect that these new .…ventures will be designed and implemented with a greater awareness of the environmental and social impact of such mega-projects.” But ‘hope’ is no basis for good risk management. Rather, what is needed are multi-stakeholder ‘ESG beta’ initiatives. These demand collaboration and co-ordination and one example would be a ‘Hydrated Industries Transparency Initiative’ modelled on the EITI.
*’Resource Revolution: Meeting the World’s Energy, Materials, Food and Water Needs, McKinsey Global Institute, Nov 2011
Raj Thamotheram is an independent strategic adviser, co-founder of PreventableSurprises.com and President of the Network for Sustainable Financial Markets