Betting the house on climate change
We only have to look as far as state government revenues to confirm that Australia is a betting nation. Two flies crawling up a wall and all that. To bet is to attempt to predict outcomes or hope that you are luckier than most. The concept of ‘betting’ seems to have worked its way into the minds of many investors, and it could have nasty consequences.
While working as a croupier in Hobart’s Wrest Point Casino to pay my way through university, I saw firsthand the power of betting on people’s lives. Some people do seriously think they have sublime mental powers that can forecast the next number on the roulette wheel. On average though, the house wins. An addicted gambler can easily lose everything.
Betting strategies are prone to spectacular failure in casinos and financial markets. Barings Bank failed soon after the Kobe earthquake in 1995. Nic Leeson had managed to conceal many large ‘bets’ on a rising Japanese stock market. The earthquake was unexpected and caused the stock market to falter. His bet failed and led to the collapse of the oldest merchant bank in London.
Do we consider Nic Leeson and Barings Bank to be unlucky? I doubt we would. To take such a large, one-way bet is a form of recklessness. And yet when investment funds blow up we often hear managers blaming ‘unexpected’ market movements – I’ve yet to hear a manager blame their own incompetence.
Unfortunately for Japan, disaster has struck again. The full implications of this latest event are still unfolding, however it is a reminder that unexpected events seem to happen quite regularly. Events like the stock market crash of 1987, the Asian financial crisis, September 11, the dotcom bust and the global financial crisis were unexpected for most people.
This begs the question: how do we differentiate sensible investment strategies from those that are reckless?
The discipline of good, long-term ‘investing’ is about acquiring a diversified portfolio of assets with the aim of generating attractive long term returns. Warren Buffet is the epitome of this approach – you won’t catch him day trading! It requires the investor to factor in both expected and unexpected outcomes.
Instead of punting on one predicted outcome, the long-term investor has an appreciation of what could go wrong and attempts to understand those impacts. It may lead to a refinement of the assets in the portfolio for the management of downside risk, but at the same time is still designed to generate good returns.
It sounds simple but human nature gets in the way.
I recall a highly respected investment analyst proclaiming that Ford could never go broke ...and it went broke a few years later. A high ranking executive once challenged me to tell him what could possibly go wrong with a huge trading position he had accumulated, only to dismiss my scenarios as virtually impossible. The "virtually impossible" happened a few months later.
A betting approach puts our fate in the hands of things outside of our control. Good investing is about managing things that are within our control, to cushion us in case the unexpected happens. After all, we’d expect any company worth its salt to run scenarios to test the resilience of its own business: What if product demand falls? What if there’s a pricing war? What if there are cost overruns on key projects?
Investors should also use scenarios to understand the possibilities. To consciously take a risk is quite different from active ignorance.
What is staggering today is that many investors are betting against adverse impacts from climate change. The science is robust enough – no one has been able to credibly debunk it – which is why the recent Mercer report recommends that up to 40 per cent of investment portfolios be invested in carbon defensive assets to reduce downside risk. It is time we recognised that a ‘do nothing’ approach is like betting against the house.
Investors are largely responsible for their own destiny. Those who carry the weight of fiduciary duty, such as superannuation fund trustees, are accountable to the members of their fund and should therefore be very interested in risk management and not ‘betting the house’.
The climate science dictates that, to have a chance of staying under 2°C of warming, we will have to fundamentally transform the way we do things. The timeframe we have to do this is in years, not decades. The effects will be felt across the entire economy; so much so that debate over a $20-30 per tonne transitionary carbon tax may look trivial when viewed in hindsight.
Investors who bet against the house on climate change and run aground in the transformation process will have no one to blame but themselves.
Phil Preston is the Principal of Seacliff Consulting, a firm offering specialised consulting services in the financial and responsible investment fields. His prior work includes 17 years of financial research and portfolio management in the funds management industry.
Comments on this article
Forget the polemic - just the facts please
"Investors who bet against the house on climate change and run aground in the transformation process will have no one to blame but themselves.'
More emotional scaremongering journalism. I'm heartily sick of trying to get what is basic information in this debate. The scientific case has not be made satisfactorily and instead of answering the questions of sceptics, we get more polemic and Ad Hominem from media, greens and other ideologues etc. "How dare you ask a question you denier!!"
Why isn't there an official Government website with questions/ claims being debated by only qualified scientists from both sides? A journo just today told me why, as she was recently told by the government ... because the Government doesn't want to give "deniers" a forum. Clearly undemocratic but worse, they're unsure of their own position and those that advise them.
This carbon tax like so much other extremist legislation which is being forced on us by just one Green politician, should go to the people.
Lorrain, the odds changed last year
Lorrain the odds against ADW changed last year when the Uppsala Universities Global Energy Gtoup published its paper on the quantities of fossil fuel available for burning.
The quantities that the IPCC use in their computer models are wrong and significantly too high.
Unfortunately many, perhaps yourself, consider such new data to be of no consequence and to be an inconvenient truth.
http://tinyurl.com/yhqn2pv
The link to the paper is in blue down the page.
Get educated!
Too many comments are depressingly ignorant - I challenge these people to turn off the shock jocks and read the peer reviewed science.. Ignorance is your choice, but you do not have the right to condemn our children and grandchildren to a nightmare world of 3 or 4 degrees. To quote Garnaut - "You ain't seen nothin' yet."
what a load of selfish idiots!
Well..it seems that the future is doomed ...if we are to believe these comments reflect the common point of view.
Perhaps we, as humans. are about to get what we deserve... such arrant disregard for the future of the planet surely makes the human race not fit to survive ..and certainly not a desireable position for the rest of the species.
Pam Maegdefrau
Getting some simple facts straight
Phil,
As I recall it was GM that went broke not Ford as you claim.
If you cannot get simple things like this right I do not like your chances on climate change.
Climate Change
Thank you Phil Preston for an intelligent and considered article. I read it with a sense of relief that the 'investment community' was as capable as any other sector of making sensible decisions in relation to rapidly the changing climate. Then I read the comments. I am now trying to recover from despair engendered by the extent of wilful ignorance and depth of scientific illiteracy the commentators (all except Patricia) so proudly flaunt, as if being very, very stupid is a badge of honour.
Mercer report
I may be confused but wasn't the crux of the Mercer report that investment criteria should be based on a risk assesment criteria rather than the traditional diversified sectors approach?
This would allow risks associated with climate change to be considered by investors and allow them to ensure that they didn't have too great an exposure to this particular risk in future.
This would obviously create a more fertile environment for companies with better sustainability practices and technologies but would not mandate a percentage investment of traditional funds into "greentech".
CRAPS
How unfortunate to introduce the allegory of gambling to climate change; but how appropriate!
Craps relies on the adage of the more the merrier in order to pull in gamblers.
Sound familiar? Could this be applied to the discussion of Climate Change
Craps - a game that relies on the power of the heat of the moment and the adrenaline rush. If you do decide to play craps make sure that you are able to maintain a degree of objectivity and detachment so that your better judgment is not unduly clouded by the baying (Climate Change) mob around you!
Craps like any other casino game is designed to ensure that the house (IPCC) always has the odds firmly stacked in its favour.
Sounds as though CRAPS was designed to support the purveyors of Climate Change - lead and they will follow!
CO2
What is oil? In just a few words it's compressed and aged rotten vegetation. Where do we find oil? In desert areas. Was it put there by aliens millions of years ago? NO! It was because trees and plants grew there. The climate changed and it all died and went to plant heaven where it got turned into oil for future generations. In those days there were no 4X4's, no Power Stations, no trains and what's more very very few humans ... and still the climate changed.
Yes the climate may be changing but it has been for eons. Carbon concentrations have been as much as 1480 and that was in the middle of an ice age. What we do now, apart from crippling our economies, will have no effect at all. If the climate wants to change it will and there is zero we can do about it. Polar bears didn't die last time, the reefs didn't cease to exist, the fish still swam and neither did the few humans around disappear.
North Sea oil is there because vegetation was and for no other reason. The deserts have oil because vegetation was there at some stage in the past and no amount of computer modelling based on what we know from the last 10000 years is going to make one iota of sense in the big picture going over millions of years whether we have a Carbon Tax or not.
Bugger the Grandkids
Giles, I suspect the Indian tribe made their assessments on what they knew .....historic events....and went from there. It would appear present assessments are being made on computer models which some say are faulty....some reason to be cautious....but not ignoring the grandkids.
Bet against the IPCC
If it's true that many investors are betting against the catastrophic climate scenarios of the UN IPCC, then I'd say most of them have it right.
A 0.7 degree celsius temperature increase over the last 100 years, whether influenced by man or not, would normally be a welcomed change to local temperatures at higher northern latitudes and for example, in a place like Japan. To imagine that a country like Japan is ever going to get as worked up about man-made global warming or man made climate change, to the alarmist levels that the green movement has achieved in Australia is laughable.
The Japanese have historically had to regularly deal with real natural disasters, rather than imaginary computer modeled climate scare scenarios. As a large population with limited land resources, their focus is also on real energy solutions, and as we have seen, including the taking of some risks. Compare this to our wind and solar PV clean green fantasy approach.
In deciding where to place our bets we need to consider the credibility of the IPCC's science of climate change. One need look no further than IPCC cheif Rajenda Pachauri's recent comments linking the Japanese earthquake with man's emissions. The IPCC has plenty of computer modellers, but they're a bit short on contributing solar experts and geologists which understand the Earth's history. Perhaps this helps explain why the IPCC have such a contorted view of the world. Either the IPCC cheif Rajenda Pachauri is not familiar with the fact that Japan is located on the edge of a tectonic plate, known as the Pacific ring of fire, or he chooses to ignore it. He is certainly prepared to use the Japanese disaster for propaganda purposes to the further the global agenda of his organisation.
Where are the returns in green energy?
The returns in green industries often rely on massive government subsidies. That is a risk that they may not stand on their own two feet. A risk that can not be ignored.
Horse betting 40% of your portfolio on "carbon defensive" investments - is really that horse betting because "green technology" has a bubble in its own making. And often these investments are not Berkshire Hathaway calibre as you may suggest - they are not making money, are massively subsidised, and have little or no track record.
Warren Buffet did make a big investment in US rail during the GFC - and apart from the low price was perhaps in his mind the energy savings aspect of rail vs road.
You brought in the recent events in Japan. What is certain there is increased global uncertainty of nuclear and expected higher demand for oil, coal, and gas - that is bankable.
You tried to bring in responsibility of super fund managers and called them horse betters. I don't think you do much investing. Many super funds closely watch and link to index results. For a super trustee to be carbon defensive means that fund results may stray too far from index results and then the fund gets penalized if the results diverge below index returns.
If I were a super trustee, I may have a separate fund option for the greenies to choose if they wish. I would not make the default option carbon defensive as I would be planning to have this very low cost, low management - not much stock picking, and reflective of the index, or mix of indexes.
There are and will be green investment opportunities. A lot of this hinges on new technologies that must be developed and brought to market and be compelling in their own right without massive government subsides. With prices of coal, oil, and gas going up there is something called market forces that would naturally help bring alternative energy innovations along nicely - without all the government intervention, bureaucracy, and unintended consequences of market distortions caused by 'policy.'
Interesting that you point out that you have the impression that not much green investing is going on. Did you think that is because the market does not think that there is much in it, because there is really not much in it? Also markets use something called discounted cash flows and net present value, and these are difficult to quantify for 50 and 100 year time horizons that greenies like to use.
Bugger the grandkids
Not one mention of responsibilty to future generations. Wasn't there a tribe of native Americans in Canada or USA who used to make impact-based decisions projected 7 generations into the future? Or something like that. Human kind is so clever at creating problems. Will we be smart enough to fix the problems we have created in the past? I doubt it. It seems from the comments that the 'I'm alright Jack stuff the grand-kids" prevails. Well Mother Nature is getting very restless. And she will have the last laugh. All the best to those genetically blessed with survival advantage. One more thing. How is it useful to have a crack at the author?
Investor Exposure.
I think you only have to look at the recent Mercer Report and their suggested climate risk strategy for institutional investors: 40% (as opposed to 1% in today's numbers) to be invested in cleatech. I would say, changes in investment strategies are slowly but surely in the pipeline and those fund managers that don't react will be held negligent. So, "path dependent" investment houses: take note.
Climate Change
Because claims of man-made climate change will turn out to be the biggest political and economic 'sting' the world has ever seen. Future generations will look at with disbelief and distain on our time, asking how could so many be conned by so few
Climate change is no bet!
The 'science' is one thing, the geological record is another.
The climate changes and we can do nothing about it... as clearly evidenced by the increasing frequency and ferocity of its events... there is no bet here.
The 'over think' that increasingly pervades all aspects of society, leads us to creating financial crisis, fixing what is not broken and 'worry' every aspect of our lives to near destruction... do we really need 30 'new model' cars every year 150cm TVs, Facebook and Twitter? of course we don't.
I believe that rushing to do something about climate change is potentially as big a problem as doing nothing, when we already know that there are have been periods of climate on Earth that have been totally hostile to human existence and will inevitably occur again no matter how many politically motivated taxes are introduced.
The question of how human society deals with inevitable climate change and its effects on our way of life, is not one of business opportunities and certainly far to important to be dealt with by politicians who have trouble just telling the truth.
Earth Change
I suspect Nature will always be mightier than man....we cannot change what will be.
Re: Betting the House on Climate Change
Phil Preston, you clearly have a soothsayer's ability to see into the future and predict all manner of disasters. How is a portfolio with a spread of bank, mining and energy stocks not mitigating risk? These industries will develop products which satisfy carbon reduction requirements - enforced or market-led - and provide income for investors. Financial "advisers" are always tut-tutting like school masters about how everyone else has it wrong. (Reminds me of the Greens, actually!) Instead of stirring up anxiety and fear, perhaps you could contribute something more constructive?
Earth Change
Considering earthquakes (and related sunamis) have wiped out 500,000 people in the last 10 years why would an investor be worried about some unquantified climate risk in the far future. The money is going to be made in the here and now so maybe we need an Earth Change Tax to help kickstart the new "new" economy.