Wellington Management: Deriving opportunity from secular climate themes
Wendy Cromwell, CFA - Vice Chair and Director, Sustainable Investment, Wellington Management
Since the 1970s, Wellington has implemented a regular firmwide research initiative we call Future Themes. Run once or twice in each decade, it aims to research and identify the structural themes that will shape the world over the next decade – and to determine their investment implications.
When the Future Themes project was run in 2020, sustainability issues surfaced as the predominant theme and a key theme within that was climate change. In many ways, this was not a new development. Wellington has long understood the importance of seeing climate as a systemic risk to long-term financial performance. We endorsed the Task Force on Climate-related Financial Disclosures framework (TCFD) in 2017 and in 2018 formalised a research collaboration with Woodwell Climate Research Center (WCRC), a top-rated climate research organisation, to study the physical risks of climate change.
However, the Future Themes outcome allowed us to broaden and deepen our understanding of the economic, technological and consumer dynamics behind the theme. Climate migration and water scarcity were studied by a cross section of investors with input from an advisory council of asset-owner partners. The initial findings of the research were presented in early 2021, and these were further refined and shared throughout the firm in interactive sessions with external experts.
This research and our work with WCRC has only strengthened our belief that the effects of physical climate change will impact society and the global economy, with implications for private and public spending, particularly on infrastructure. We expect that as the world pursues low-carbon pathways, new opportunities and a changing competitive landscape will emerge, particularly for resource efficiency, clean energy, low-emission products and services, and climate resiliency.
Secular climate risk
Overall, we believe climate change is a secular theme that presents risks to businesses that are unable to adapt to a changing environment, and opportunities for those that can – or have a role to play in mitigating those changes. We believe both the risks and opportunities are underappreciated by the market.
Our research on climate has allowed us to incorporate climate risk into the way we conduct our fundamental research on companies. We assess corporate strategies and capital expenditure plans, among other factors, to understand how companies are positioning themselves to adapt to or mitigate these risks. Specifically, we seek untapped pockets of opportunity, identifying companies that may experience profitability tailwinds or headwinds associated with climate change risk, the sectors that are likely to become larger and more important, or smaller and less relevant, and seek to structure portfolio exposures to best align with these shifts.
Wellington’s sustainable investments
We believe investments that foster a sustainable future are poised to benefit from it. Our sustainability- and ESG-oriented investment approaches invest across the spectrum of liquid and illiquid securities, incorporating sustainable investment factors with the objective of outperforming benchmarks and delivering competitive returns for our clients. These approaches include ESG forefront investing, thematic investing, climate-focused investing and impact investing.
Global impact funds
In fact, it was the 2012 Future Themes project that led to the creation of the Wellington Global Impact Framework – global equity and bond strategies that seek to solve the world’s most pressing social and environmental problems while generating competitive financial. Unlike our ESG investment funds, which focus on how investee companies do business and treat stakeholders, our impact funds look at the change that can result from what a company produces and sells. Our impact funds focus on mitigating the effects of climate change, ensuring access to basic life essentials and reducing inequality. Measurement is key here, and for every company held in this and similar impact strategies, we produce key performance indicators (KPIs) that seek to quantify the level of impact the issuer has on society or on the environment.
The notion of sustainability and stewardship of clients’ assets was instilled in the firm by our founding partners. It continues to be a guiding principle. At a challenging time, we believe it is the duty of current generations not just to preserve but to improve the world for the next generation. This commitment to continuous improvement is embedded in our culture and reflected across the full range of our sustainability practices.
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Investment implication examples: Low-carbon electricity The firms that are best able to tap into the growth of renewable energy and alternative fuels have the potential to generate attractive returns. The same is true of businesses that can become a key part of the redesign of energy infrastructure. But the transition to low carbon also carries risks. Companies in high-emitting industries within countries with carbon pricing risk harming their profitability if they are unable to pass tax or Emissions Trading System credit prices through to customers. When we analyse energy and utilities companies, we assess whether they have embraced the energy transition to lower their cost of capital, maintain operating licenses, and align production with increasing demand for lower-carbon energy sources. Failing to account for these risks may limit access to capital or raise costs. Companies that resist the low-carbon transition, and those that may have misled consumers and investors, face growing litigation. The financial risk is costly litigation fees, damages, and remediation requirements. Water and resource management The businesses that dominate the growing market for pollution controls, agricultural technology and waste management have the potential to generate strong and sustainable growth. Yet as consumers become increasingly aware of carbon emissions associated with certain agricultural practices, there are risks for food companies unable to diversify. Agriculture too is increasingly vulnerable to an overall rise in temperature alongside more frequent and severe weather events and related declines in ecosystem services from pollinators. For companies and assets located in regions experiencing physical climate impacts, crop and animal product yields may decline, operating costs may be more volatile, and ability to grow incumbent crops may be compromised. |
Investment Risks
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