Investing in Climate Change 2011
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Investing in Climate Change 2011 The Mega-Trend Continues: Exploring Risk & Return February 2011 Whitepaper available online: http://www.dbcca.com/research Carbon Counter widget available for download at: www.Know-The-Number.com Climate Change Investment Research Mark Fulton Managing Director Global Head of Climate Change Investment Research New York Bruce M. Kahn, Ph.D. Director Senior Investment Analyst: New York Nils Mellquist Vice President Senior Research Analyst: New York Emily Soong Associate New York Jake Baker Associate New York Lucy Cotter Associate London We would like to thank the following individuals from Deutsche Bank for their insight: Paul Buchwitz, Christopher Burnham, Tom Curtis, Mark Dominik, Gisele Everett, Sarah Foley, Holger Frey, Justine Gordon, Bart Grenier, Jamie Guenther, Eric Heymann, Nicolas Huber, Tobias Just, Frank Kelly, Nektarios Kessidis, Marc Khouzami, Christoph Klein, Matt Kondratowicz, Roelfien Kuijpers, Stephen Lieu, Sabine Miltner, Landy Pheloung, Alex Preininger, Franziska Reh, William Reid, Laura-Susan Shuford, Paul Spence, Dominik Thumfart, Elizabeth Zieglmeier We would like to thank the following other individuals for their insight: Hewson Baltzell, Michael Carboy, Daris Delinis, Mario Lopez-Alcala, Craig Metrick 2 Investing in Climate Change 2011 Table of Contents Page Editorial……………………………………………………………………………… 4 Key Themes …………………………………………….………………………… 5 I. Climate Change Investment Thesis: Managing the Five Pillars of Risk …………………………………………….…………..….…. 18 II. The Investors…………………………………………………………...…… 34 III. Policy Developments.................................................................................. 42 IV. Climate Change Investment Markets and Asset Classes….. 73 Overview…................................................................................................... 73 PE / VC…....................................................................................................... 78 Infrastructure …………………………………………………………….. 85 Public Equities…………………………………………………………… 91 Fixed Income …………………………………………………………….. 96 Carbon Overlay …………………………………………………………. 102 Quantitative Risk / Return………………………………………….... 106 V: Growth Outlook for Climate Change Sectors……………………. 110 Appendix……...……………………………………………………………………... 127 Climate Change Investment Universe…........................................ 127 GET FiT…....................................................................................................... 128 Tracking Momentum…........................................................................... 131 3 Investing in Climate Change 2011 Editorial Kevin Parker Member of the Group Executive Committee Global Head of Asset Management In previous reports we looked at the performance potential of climate change related investment. In this report, we shift our focus to examine in more detail how investors can manage the multifarious risks that ultimately are driven by the potential physical impact of climate change on industry and society. This shift in focus reflects the considerable uncertainty both in markets and in government policy related to climate change throughout 2010. In response to this uncertainty, institutional investors are giving greater consideration than ever before to climate change in their assessment of asset allocation. It is confirmation of the importance of this trend among investors that Mercer Investment Consulting has just published a report looking at the issue of climate change risk at a portfolio level. I believe that we have, in fact, reached a critical point in our industry. It is the point at which all the talk about climate change begins to translate into action. While politicians and others in some parts of the world prevaricate, asset owners everywhere are starting to move. Naturally, their first impulse is to identify where in their portfolios the climate risk lies. Their next impulse is to adjust their allocations to take account of this. To do so effectively and efficiently, they need a new intellectual framework and set of tools. And they need them now. We have therefore used this report to study the risks associated with climate change investing across different asset classes and provide frameworks to understand how asset managers can handle those risks. And we examine how various climate change strategies can be added to a portfolio as investors make their allocations. We believe our report complements Mercer’s portfolio level work by digging more deeply into the question of risk in different asset classes than any climate research of which we are aware. And I would like to emphasize that we eat our own cooking. As fiduciary investors, our own response to greater client focus on climate risk is two-fold. We have, first of all, built climate change information into the fabric of our investment process, ensuring that it is taken carefully into account as investment decisions are made at the portfolio level. We are, for instance, not only signatories to the UN Principles for Responsible Investment but have trained our entire staff in the PRI. We also provide our portfolio managers with tools and information critical to climate change that inform the choices they make. Secondly, we are developing innovative strategies across all asset classes – public and private equity, bonds, real estate and infrastructure - that are designed to help clients understand and manage climate risk. It is extremely encouraging to see that in many parts of the world governments are responding to increasing investor demand for policy frameworks friendly to climate change investment. Also contained in this report is our updated global data base of policy initiatives. It clearly shows that, despite often challenging economic conditions, countries as diverse as Germany, China and Brazil are forging ahead in creating policy frameworks that provide what we call TLC – Transparency, Longevity and Certainty. Even in the US where the federal government continues to hesitate, a great deal is happening at the state level in places like California, Texas and New Jersey. What we are seeing is the intersection of two critical trends. On one hand, investors are increasingly getting to grips with the risks inherent in climate change. On the other, the investment opportunity steadily continues to improve globally. In this powerful combination lies the solution to unlocking the investment capital necessary to defeat climate change. 4 Investing in Climate Change 2011 Key Themes Mark Fulton Managing Director Global Head of Climate Change Investment Research New York Investing in Climate Change 2011 looks at the key investment drivers in climate change strategies and how they play out at the asset class level in terms of risk and return. In this introductory section we look at the paper in terms of eight key themes: 1. The megatrend persists: Managing risk and return for investors. 2. Exploring risk for investors: How to manage economic, technology, and most particularly policy risk and overall portfolio risk – overall risk hedge for climate in portfolios. 3. Policy: Key driver for cleaner energy. 4. Chinese leadership: It is not just the number of new policies, but rather the ambitious scale, scope and commitment to foment major structural change. 5. US Federal policy has disappointed in relative terms. Global investors have to rely on key states, such as California, New Jersey and Texas. 6. Natural Gas as a lower-emission transition fuel in the US. 7. Climate markets and returns have offered varied performance across asset classes and sub-sectors. 8. In the run up to and following Cancun, global policy makers recognized the need for a more in-depth dialogue to explore how public and private sector funds could most effectively deliver support to renewable energy scale-up and energy access in developing countries. 1. The megatrend persists: Managing risk and return for investors. Climate change is a long-term trend which will affect the value of assets in the real economy and will produce long-term investment opportunities. We define the Climate Change Investment Universe as those companies that mitigate climate change by developing low-carbon emissions technologies or adapt to climate change; e.g. companies that foster energy efficiency and cleaner energy, or respond to new pressures on society and the economy from climactic changes, such as food production and water management. The transition to a lower carbon economy creates opportunities for active asset managers, but also requires understanding the supply and demand dynamics of traditional energy commodities such as natural gas, coal, oil as well as agricultural commodities. Total capital deployed continues to rise, although on a global basis needs to rise significantly to support climate stability. According to Bloomberg New Energy Finance (BNEF), investment in clean energy asset classes has increased since 2004, and investment in 2010 was the largest year yet on record. Asset finance (investments in large scale clean energy projects) is the largest single area of investment. This is an infrastructure play. Small-scale renewable energy investment (much of which is solar PV in Germany) is captured in the small distributed capacity category. This figure is only reported 5 Investing in Climate Change 2011 Key Themes by BNEF once a year, so it is not always recorded in intra-year investment totals. Additional breakdown of the asset class level investments is reviewed in the Markets chapter of the document. Total global investment in clean