What are we looking for?
Countries that are prepared for a greener economy.
Climate change is one of the major issues of our time, and the (hopeful) transition to a more climate-friendly economy presents both risks and opportunities for investors. Thus, many savvy investors are considering a company’s carbon footprint in their bottom-up company analysis.
However, more than 80 per cent of a portfolio’s returns and risk over a longer time horizon (10 years or more) are attributable to the strategic asset allocation – how much to invest broadly in which countries and sectors, rather than which specific companies.
Therefore, long-term investors are also considering climate change in their overall economic assumptions that drive their asset allocation decisions. Climate risk can be broadly broken into physical risks – such as wildfires, severe weather, or assets being under water (literally, not financially) – and transition risks, such as (potential) decreasing demand for fossil fuels.
According to a recent report by Ortec Finance for OPTrust, one of Canada’s largest pensions, physical risks are likely to manifest as of mid-century, and over the next decade, transition risks are key. Canada is relatively less vulnerable to physical risks, but with 20 per cent of our exports coming from direct fossil fuel exports, and the relatively high marginal cost of producing fossil fuels, Canada is vulnerable to transition risks.
Countries or regions that are better positioned to handle this transition could be seen as safe-havens by large institutional investors, and would therefore make good long-term investments. Canada is the 10th largest economy in the world. We will look at how the rest of the 10 largest economies compare from a transitional climate-risk perspective, and which countries investors, who are concerned about disruption from climate change, might consider greater exposure to.
- First, we consider the country’s GDP per unit of energy use (in this case, kilogram of oil equivalent) to see which countries are the most, and least, energy efficient;
- Secondly, we look at how this is trending, measured by the percentage change over the past 15 years;
- Finally, we will consider the companies’ in the countries Refinitiv ESG scores. We will take the market-cap weighted average Emissions and Environmental Innovation Scores;
- The final column is how these countries rank relative to each other if all four data points are given equal consideration.
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What we found
Europe appears to be far and away the most resilient to transitional climate change risk, with the four European countries ranking in the top four places, led by Britain. Investors interested in broad, passive exposure to Europe could consider Vanguard’s European Stock Index exchange-traded fund (VGK) with a 0.09-per-cent management expense ratio (MER). For pure Britain exposure, there is Franklin Templeton’s FTSE United Kingdom ETF (FLGB), also with a 0.09-per-cent MER.
For those interested in a more active, stock-picking approach, Persimmon (PSN-L) is a British homebuilder that scores in the 100th percentile in Refinitiv’s StarMine Combined Alpha Ranking, and has the maximum amount of exposure to the British economy as measured by Refinitiv’s StarMine Country of Risk Model.
Hugh Smith, CFA, MBA, is an investment management specialist at Refinitiv.