Long-term investment thinking for climate markets - The Trend Is Blue
The author of the bestselling “Swim with the Sharks”, Harvey Mackay, was in Japan in 1983 and chanced to meet the 88-year-old president of Matsushita Electric. Mackay asked him, “Mr. President, does your company have long-range goals?” Matsushita’s president replied “Yes.” Mackay then posed his second question, “How long are your long-range goals?” The answer to this question will take many today by surprise: “Two hundred and fifty years.1”
At this year’s 8th Annual Clinton Global Initiative, a gathering of 1000 leading thinkers from the spheres of politics and industry, amongst others, contemplated the implications of increasingly ‘short-termist’ business practices geared towards immediate results (over 2-3 years) rather than long-term benefits (over 10-15 years).2 With the current economic slowdown, even the conventionally investment-inclined pension funds and insurance companies are prioritising immediate returns and taking on far larger risk burdens3.
Carbon markets are thinly-traded (Illiquid) and require patience. A thinly-traded market is one in which the volumes traded are low compared to other markets because of the low number of buyers and sellers. Consequently, prices are more volatile and assets may be defined as illiquid. Illiquid assets cannot be sold quickly because of the relative lack of ready buyers, unlike other assets such as stocks and bonds.
Yet trading in thinly-traded commodities, such as carbon credits, is not without (many) advantages. For one, they offer potentially better returns. Roger Ibbotson, a professor of finance at Yale School of Management, led a research project which demonstrated that thinly-traded stocks tend to do better over time than more actively-traded stocks. In an interview in the Forbes magazine, he explained that the comparison of stocks dating from as far back as 1972 produces the conclusion that thinly-traded stocks out-perform highly liquid ones in all four quartiles (ranked by size). The spread, according to Ibbotson, ranged from 12 percentage points per annum between the least and most actively traded micro-caps, to 2.8 percentage points between the least and most popular mega-caps.
The expectation of future increase in the volume of turnover contributes to the interest generated by thinly-traded markets such as carbon markets. The carbon market has grown thirteen-fold between 2005 and 2012, and in 2011 voluntary carbon markets witnessed transactions exceeding $572 million in value, according to a report by Ecosystem Marketplace report 4. In addition, Bloomberg projects that trading volumes in voluntary markets will rise from 94 million, to 600 million tonnes by 20205
The recently released Kay Review concludes “that short-termism is a problem in UK equity markets, and that the principal causes are the decline of trust and the misalignment of incentives throughout the equity investment chain. 6”
The same can be said for climate markets, where the focus on immediate results compromises firms’ long-term fortunes. The reduced investment undertaken by individuals and corporations in assets - the items which really provide them with their competitive edge - increases their susceptibility to long-term risks and negative consequences.
With perceptions of unfairness being identified by the Kay Review as a key contributor to short-termist mentalities, research carried out by the London School of Economics has explored how governments can begin to ameliorate these concerns through improved policy-making and communication7.One of the key recommendations which this report makes is to price carbon at around GBP 30 per tonne of carbon-dioxide-equivalent. Another suggestion is to have policies “which promote innovation and appropriate infrastructure investment.”
Encouragingly, the commitments to sustainable practice exhibited by a number of companies are a sign that long-term investment strategies exist as more than paper-talk concepts, and that firms recognise the long-term benefits that might accrue to them through emissions reductions in the present. A case in point is Marks & Spencer’s Plan A, through which the firm aims to reduce its carbon footprint and hence achieve its ultimate goal of becoming the world's most sustainable major retailer. Launched in January 2007, with 100 objectives spread across 5 years, it has now been expanded to include 180 targets to achieve by 2015. Through Plan A, M&S is working with customers and suppliers to combat climate change, reduce waste, use sustainable raw materials, trade ethically, and help promote healthier lifestyles8. In 2012 M&S reported that Plan A generated GBP 70m in 2011 and GBP 105m in net benefit. M&S’ innovations include: clothes exchange programmes; extra charges for carrier bags; and the option of purchasing carbon-neutral items in their various product ranges, with chocolates a well-known example9
Marc Bolland, Chief Executive Officer of M&S, has said, “After five years of Plan A we have made good progress. By achieving 138 of our sustainability commitments we have made Marks & Spencer more efficient and innovative, whilst also benefiting society and the environment. Today, Plan A is integral to our strategy for future growth. We are pleased with our progress so far but not complacent; the biggest challenges still lie ahead.”10
M&S’s CO2 emissions in 2006-07 and 2011-12
The solidity of the carbon market may be gauged from the fact that it is projected to triple from its 2010 size by 2020, when it will be worth some $2.2 trillion11.The benefits of balancing immediate with long-term objectives are thus extremely clear. Not all investments produce results overnight; the best of them might just be those that mature over a longer span of time.
Risk Warning: This blog is for information only and does not constitute investment advice. Holding carbon credits for the purpose of financial gain is speculative and involves risk. There is currently a thinly traded market for carbon credits.