Investors should be jumping at the chance to allocate to climate-change strategies, which are a potentially more lucrative play than hedge funds, according to a paper co-authored by GMO co-founder Jeremy Grantham.
Climate change has become a major risk to the economy as hurricanes, droughts, and wildfires cause record damage, Grantham and GMO portfolio manager Lucas White wrote in a paper this month. Investing in green energy companies that mitigate this risk will pay off as demand for their products and services will rise, they argued.
The potential for equity-like gains (or higher), inflation protection, and diversification should be intriguing to investors — especially in comparison to hedge funds, according to GMO. “Hedge fund investors typically accept low returns, high fees, and illiquidity in the quest for uncorrelated returns,” White and Grantham wrote. “Climate change investors will be able to enjoy the benefits of diversification without making such sacrifices.”
The world is “rapidly approaching a time” when it will be forced to act aggressively to make up for decades of inaction on an existential threat, they said. This effort will set the stage for high growth — and potentially strong returns — in the sector, according to the paper.
GMO, a Boston-based asset manager known for value investing, is seeking to identify companies that trade at a discount while benefitting from the secular-growth tailwinds of a changing climate. Value strategies typically are cheap and lag market growth, but Grantham and White see the environmental crisis as a way to buy faster-growing companies at a discount.
“Many investors believe that it’s somewhat paradoxical to buy ‘cheap’ stocks in a growth universe,” they said. “If we can continue to own a portfolio of companies trading at a discount without sacrificing growth, we believe we can generate strong performance over the long term.”
Since inception in April 2017, the earnings growth of the GMO Climate Change Strategy has been higher than the MSCI All Country World Index while consistently trading at a 15 to 20 percent discount to the benchmark, according to their paper. To underscore their point that value investing works well when targeting growth companies, the authors said the cheap half of the Russell 1000 Growth Index has produced larger annualized gains than the Russell 1000 Value Index since inception in 1978.
Very few investors have a bucket for climate change, according to GMO.
“Outside of global equities, the most natural home for a climate change strategy for many portfolios may be in the real assets allocation,” White and Grantham said. While investors may also carve out room for the strategy within their environmental, social, and governance allocations, they said “the most interesting framing” may be to consider climate-change investing as insurance.
“There’s a significant risk that climate change will have a considerable, unpleasant economic impact,” the authors wrote. “It seems reasonable to think that investors would want to protect themselves from this risk, and investing in a climate change strategy would be a good start.”
Their paper cited the “Fourth National Climate Assessment,” released under President Donald Trump, which concluded that climate change is expected to cause substantial damage to the U.S. economy throughout this century.
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A shift to clean energy will involve tremendous investment and time, White and Grantham said, estimating that trillions of dollars will be needed to decarbonize the economy and overhaul energy grids. “Fortunately, by investing in the clean-energy solutions that compete with fossil fuels, one can maintain that exposure to traditional energy prices,” they wrote.
If prices of damaging fossil fuels rise, clean energy becomes more competitive, speeding up the transition to a clean energy infrastructure reliant on materials such as copper, lithium, nickel, and cobalt, according to GMO. “Because of the indirect exposure to fossil fuel prices and direct exposure to clean energy materials, agriculture, water, and infrastructure, we believe the climate change sector, as we’ve defined it, will perform well in certain inflationary environments,” White and Grantham said.
While there’s no “standard operating procedure” for investing in climate change, they urged allocators to come up with a strategy so their portfolios may benefit from the winners that battle it.
“It’s up to investors to figure out how a climate change strategy fits into their particular investment process, but we expect it will be worth the effort,” they said.
