Engineering portfolios for climate change
A review of climate change from the global energy mix to net-zero offsets, and how institutional investors can integrate climate change solutions within portfolios.
Welcome to the Center for Investment Excellence, a production of JPMorgan Asset Management. The Center for Investment Excellence is an audio podcast that provides educational insights across asset classes and investment themes.
Today's episode is on climate change solutions and investing, and has been recorded for institutional and professional investors. I'm David Lebovitz, global market strategist and host of the Center for Investment Excellence.
With me today is Garrett Norman, investment specialist from our Quantitative Solutions team, and Meera Pandit, global market strategist. Welcome to the Center for Investment Excellence.
Thanks for having me.
Happy to be here with you both.
David Lebovitz: So, want to kick things off here, and Meera, maybe we'll start with you. The shift towards climate change solutions has begun. It began years ago, it has been accelerated during the pandemic. Would love to just start at kind of 20,000 feet on this one. Can you give us the latest on what's happening with respect to the global energy mix specifically, around the world, not just here in the United States, as well as the latest thinking around achieving some of the net zero targets that have been laid out here over the past couple of years?
There is this broad recognition really from all of the actors in the global economy that climate change is likely to cause some pretty significant consequences if we don't work to mitigate it on its current path.
So we're seeing this huge momentum from policymakers, from consumers, from corporations, regulators, investors, really trying to mitigate some of these impacts of climate change by reducing or even offsetting to the extent that they can some of these greenhouse gas emissions.
So, policymakers are going to kind of lead the charge here, setting some of these net zero carbon emissions targets globally. And while it's great to see some of these commitments, we have to see the rubber hit the road and really understand how these things are going to be implemented. Because if we actually want to see successful implementation here, we're going to need to see trillions of dollars every year committed to things like infrastructure, research and development for new innovation, subsidies, regulation, carbon pricing in some cases as well.
But that's really going to set the foundation for the private sector and for this innovation going forward. And in fact, we're already seeing massive capital flow into some of these opportunities already. The private sector is responding to shifting consumer preferences and what those demands are, because ultimately in the U.S., the consumer is 70% of the economy. So what the consumer demand is what we tend to see companies try to respond to, and we are indeed already seeing that.
And I think it's interesting, Meera, something that you and I have talked about, particularly over the past 12 or so months, we're finally in this world where consumer preferences and government policies are aligned, and that's really a powerful combination that suggests things may actually get done here going forward in a bit of a better way than has been the case up until this point. But before we talk about this key climate change solutions, I think it makes sense to talk about what is causing the problem, right? What has created the need for these solutions?
And so, can you spend a little bit of time talking to us about what is contributing to climate change, not only from an energy product and a consumption standpoint, but from some of the other sources that are also in need of active reduction?
Sure. So if we break down where all of these different emissions are coming from, about 73% of total greenhouse gas emissions does come from energy, but that can be further subdivided into energy usage in buildings, in industrial processes, in transportation. And what that means is the way we're going to have to tackle this is in many different ways pulling on a number of different levers.
And outside of the spectrum of energy, you see that 18% of emissions actually come from agriculture, another 5% from chemicals and cement, all of the different energy intensive materials, and finally, about 3% from wastewater and landfills.
The number of different sources here and, unfortunately, there isn't one silver bullet in order to pull on that lever and be able to solve most of the problem, you really do have to find very targeted and tailored solutions to reducing emissions in each of these categories to make some meaningful progress here.
And it's interesting because this focus on emissions basically comes up in every conversation that we're having, particularly with our institutional clients. You know, we just wrapped up our 2022 alts outlook call where we talked about forest land and the role that that type of asset can play in helping to manage carbon emissions.
But what are some of the other solutions that you're seeing weave their way into portfolios? Obviously, there are a lot of moving parts here. I mean, you just highlighted four or five, six different areas that are all generating emissions. And so, when it comes to dealing with those emissions, what are some of the key climate change solutions that you're seeing investors weave into their portfolios?
Because energy is the biggest source of emissions, renewable energy is going to be critical to solving this problem. Of course, we've seen the rise in solar and wind, and I think that that really represents an interesting intersection between policy and innovation, because you've seen subsidies that have helped allow new entrants into the space. They've consistently tried to make the product better and therefore even more cheap as well. So you're kind of seeing that feedback loop there.
But it's not just build a bunch of wind farms and add solar panels to your buildings and homes. It's how do you think about storing that solar and wind power, transporting it? How do you upgrade the grid? So that ecosystem around renewables is important.
It's also about transportation, things like electric vehicles, not only for private use, but for public use. Efficiency, how do we make sure appliances and buildings are more efficient, that we are managing waste and agricultural practices better? I mentioned consumer preferences. You know, food certainly tends to be one interesting area where we're seeing alternative meats and different types of packaging.
Similarly, fashion, when you're seeing more recyclable materials, striving to be more local in supply chains.
So there's a myriad of solutions. I think the interesting thing for investors is the fact that there is consistent global demand for a lot of these innovations and solutions, which should create an important and interesting opportunity for investors themselves.
You can see the growth in real time. I was up over the last holiday weekend doing a little bit of skiing near my alma mater in western Massachusetts. And at the ski resort, they now not have one but probably closer to 10 or 12 wind turbines lining the ridge, that they actually use to power not just the ski mountain itself but the surrounding town as well. And so you're seeing this happen in real time. It's a trend that I don't think is going to reverse itself anytime terribly soon.
So, Garrett, I'd love to bring you into the conversation at this point. Maybe just start by expanding on some of the things that Meera just shared. You know, can you highlight where you're seeing opportunities across the space as somebody who looks at it day in and day out?
Absolutely, and I think Meera framed very well the broad scope of the problem, but then the broad scope of the opportunity. If you think of the trillions of dollars of spend that's needed every year, I think estimates are by 2050 it's 140 trillion, depending on your source or categorization, and thinking of the solution providers, they're the beneficiary of those quotes, right? They're not the spender, they're the receiver or beneficiary of what's needed in terms of the innovation across the economy.
And so we thought about this problem from a holistic and broad sense trying to identify subcomponents, as Meera spoke about, renewables and electrification as an example, or sustainable construction.
And I think the key is that, if you're thinking about how to, A, help be a part of the solution, or B, take advantage of the investment opportunity in public equity markets, there's a number of companies that have already developed solutions that have the technology, and for them it's about scale and taking advantage of the environment.
And I think going into that in a bit more detail, the electrification element is a huge one for us when we think about individual stocks and companies. You're seeing, of course, the build in solar and wind, but really across the range of how we're going to reduce the need for fossil fuels.
We need to rely on electricity, whether that's the connectivity into renewable energy, whether that's related to electric vehicles, whether that's related to heat pumps to replace gas boilers. All is going to depend on the electrification of the grid and whether there's enablers on the software side in terms of power management, whether it's on the hardware side in terms of the electrification process itself or just in battery and storage.
I think an interesting example, and I'll come back to, I guess, the wind example you mentioned, David, and bring it over to Europe, in that you look at Denmark right now as a country, and on a windy day, the country can cover its energy needs from the wind capacity. However, they have gotten rid of fossil or dirty fuels, and so on a non-windy day, there's an energy gap.
You move a little bit north, you have Norway that has significant hydrogen energy capabilities. Again, more than they would know what to do with on certain days and in certain environments. And so there's an opportunity in terms of connecting the hydro energy up in Norway with the wind energy down in Denmark to ensure a consistency of energy demand and connect that into the grid.
And so from us thinking from a public equity investment opportunity, we're looking at the companies that are involved in laying the cable under the channel between those companies and managing some of that connectivity.
I think also maybe another one I'd hit on is in that sustainable construction or energy use in buildings as another one where there's a high relevance today. And again, this comes back to the need, but also opportunities, for companies. If you acknowledge that about 15% of the costs of running a building relates to heating and ventilation, and that there is meaningful opportunity to improve the efficiency, both from a cost perspective, but then reducing that greenhouse gas emissions footprint.
So we're looking at names that are specifically involved in the HVAC space. Thinking of two of the top names in our portfolio, or actually even adding a third, they can account for about three gigatons of greenhouse gas emissions reduction. And if you think of the problem now is we need to get from 50 gigatons down to zero, three alone can be spoken for in a narrow part of that HVAC element within sustainable construction.
Other examples are simple or tangible as well, thinking of LED lighting, again, as a much more efficient technology or process. You know, benefits providers from a cost standpoint, but also has benefits from the emission and carbon footprint side of the coin.
Excellent. That's really helpful. And coincidentally, I'm sitting in a room with LED lights, so it seems like that transition is already underway in certain residential markets.
Maybe, want to stick with you, Garrett, for a second and then bring Meera back in to get some of her thoughts. You know, for a lot of people, investing is a balancing act where we're balancing risk and return. In the context of today's conversation, we're balancing sustainability and return.
What do you think is the right framework for institutional investors to employ as they think about either investing is sustainable investing for the first time or if they're looking to expand their allocation? But what's the framework that we should be using here given that so many folks are unfamiliar or inexperienced when it comes to deploying capital into these types of strategies?
Yes, it's a great question and certainly an important topic as the space continues to evolve and mature.
And I think, broadly speaking, you can think of it as a spectrum of sustainable strategies where you can sit on almost the left, if you will, from a visual perspective on strategies that are just making tilts or exclusions, right? You can try to lean out of the worst offenders, lean into the best across E, S or G pillars, and I think that's a good and needed first step in responding to risks and opportunities are being borne by some of these environmental and social issues.
Certainly, climate change is a very prominent environmental one. But we're seeing more interest in it, and I think trying to respond to, at a firm level, is skewing more right on that spectrum, into more thematic or impact or outcome based strategies where it goes a step further into, okay, I'm not just on the margin trying to accommodate for risks and opportunities, but I'm really trying to harness and capture them in a more concentrated and direct fashion.
So, for us, thinking about climate change, that would mean developing a strategy where you have a more concentrated holding of these solution providers, try not to constrain yourself, go across sectors, go across the globe, let a strategy evolve over time. I mentioned today a lot of the opportunity being in electrification and sustainable construction, tomorrow that could change more to hydrogen power, to carbon capture, to other what's now greenfield technology, but will continue to come down the cost curve and be a larger, more significant part of public equity market.
We're watching that journey of, you know, crucial to integrate from an ESG perspective, better to start leaning into those best-positioned companies but can take that a step further into the more thematic outcome and impact-oriented strategies.
In a traditional portfolio sense, you think of core and satellite, and I think that has a role in a sustainable element as well. When I talk about maybe a more concentrated target into climate change solutions that should have a high alpha potential, that will come with tracking error and volatility. And so I think marrying some of what we know and love from risk budgeting and portfolio construction frameworks can also be applied into the sustainable investing paradigm.
Yes, I mean, that makes a lot of sense to me. And Meera, I'd love to get your thoughts on this as well, you know, particularly given that you've worked with me on our guide to alternatives where we tend to focus more on investments that sit on the private side of the ledger. You know, how do you think investors should think about accessing these opportunities in light of what Garrett just shared?
To Garrett's point, it's about toggling between: do you want more indirect exposure in terms of companies that are established and trying to optimize or adapt their business models towards having better climate outcomes? Or, do you want to approach it much more directly for some of those impact investments? And then, how do you think about public markets versus private markets?
In the public market realm, you want to look for companies that already demonstrate some ability to generate revenue and ability to generate profits as well. And of course, the first step is actually having a viable product that can be scalable. And you can find a lot of that within the public market spectrum. What you might find in the private market spectrum is some of those moon-shots, things like next-generation battery technology, hydrogen carbon capture.
That's going to come with a lot more risk, but potentially a lot more reward. So it's all about that risk tolerance and liquidity profile as well if you're thinking of dipping your toe into the more private end of the spectrum.
It seems like the key word here is balance, which really isn't all that far off from sustainability. And so, Garrett, maybe I'll give you the last word here. How does the team think about everything that we've covered today? How do you think about it internally? And what do you think institutional investors should care about the most as they look into the future?
You know, is this just another trend, or is this something that is here to stay? Maybe to bring this to a close, we can just wrap up with some thoughts around those couple of issues.
Absolutely. It is certainly an area where we think there's meaningful staying power. It's one of the highest conviction long-term opportunities that we see in markets, and I think that speaks to, yes, there is an element of being part of the solution, which can have a virtue element to it.
But I think that notwithstanding, there's just such a meaningful investment return opportunity that I think could be interesting for a wide range of institutional investors. You need to bring together a number of different resources and capabilities in truly capturing or expressing.
So, for example, we've been talking about climate change solutions and it's spanning a wide range of sectors and industries. How you can organizationally think about identifying and seizing those opportunities is really crucial. Certainly, from a JPMorgan perspective, for us, that's marrying some of our quantitative and machine learning capabilities with the fundamental active insights of our global research analyst teams. It's finding ways to bring those together.
And then doing some of those next levels of, okay, not just what are the companies associated with this climate change space, but which companies are managed sustainably, which ones are actually driving to the solution from a revenue perspective, from a profitability perspective.
Last but not least, what's the valuation of those companies? Right? I think putting it together in a package where you are managing from an alpha and long-term capital appreciation perspective, you know, really ties with the staying power the theme and makes it an important strategic or long-term holding for institutional clients and investors.
Excellent. Well, I think that's a perfect point to finish on. So, Garrett, Meera, thank you both so much for joining me today, and I'm looking forward to hopefully having you both back sometime again soon.
Thanks for having me.
Thanks for having us.
Thank you for joining us today on JPMorgan's Center for Investment Excellence. If you found our insights useful, you could find more episodes anywhere you listen to podcasts and on our Web site. Thank you.
Recorded on January 20, 2022.
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