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The decisive decade

Rory Goodman
Director – Private Wealth

I was a latecomer to HBOs Chernobyl series, having only just sat down to watch it two years after its release (I was much quicker off the mark with Tiger King). I was struck by two things in particular.

First – a realisation of my own ignorance surrounding the events. It was far more complex than an explosion at a nuclear power station. Second, and more importantly – the parallels that can be drawn between Chernobyl and the climate crisis. The covering up of scientific evidence, cost concerns curtailing decisive action and a preference for the status quo. The inevitable chaos that ensued.

Yet whilst the tragedy of Chernobyl has played out in full, we find ourselves at the ‘chaos’ stage of the climate crisis. Fortunately, action is being taken, and nowhere is this action against climate chaos more apparent than in the United States.

FIRST, A PLEDGE

This will be a decisive decade to overcome the existential crisis of our time” US President Joe Biden

Joe Biden’s first day as president was marked by the welcome re-joining of the US to the Paris Agreement – climate change is front and centre of his strategy. Fast forward to late April, and he hosted (virtually, no less) the Leaders Summit on Climate, coinciding with Earth Day. Many countries used the summit to update and accelerate their own emission reduction targets (Nationally Determined Contributions), but the US stole the show. President Biden pledged to cut greenhouse gas emissions (from a 2005 base) by at least 50% by 2030, doubling the previous target set under the Obama administration. The ambition and importance of this latest pledge should not be underestimated, not only due to potential impact on global emissions (the US is currently the largest emitter of CO2 outside of China), but also due to the global economic and monetary implications that may stem from it.

In spite of these recent pledges, Climate Action Tracker estimates that even accounting for the successful implementation of all known climate pledges on a global basis, there is an 80% probability of temperatures rising by over 2°C by 2100.1 This would fall short of the original objectives of the Paris Agreement and is even further away from the updated 1.5°C goal scientists believe is required to prevent dangerous anthropogenic interference with the climate system.

 Click to view larger image

Whilst we can expect a range of additional policies and initiatives to be announced ahead of the crucial COP26 conference in November, they are unlikely to be enough. Policymakers need to act in a more co-ordinated fashion with unprecedented speed and scale. Recent estimates put the cost of implementing changes required to meet the Paris Agreement at $73 trillion.2 But as the US Treasury Secretary, Janet Yellen has emphasised: “The cost of inaction is too great. We must fuel a clean energy revolution.”

WHO WILL PAY FOR THE REVOLUTION?

Higher tax rates seem likely, but a much larger slice of the pie looks set to be paid for by the public purse, whose strings have already been dramatically loosened in response to covid-19. The effectiveness of supportive fiscal policy has been evident throughout the pandemic – turbocharging growth prospects for many countries in the coming year. The fiscal genie will be hard to put back in the bottle and tackling climate change through a ‘green recovery’ is becoming a key priority for many governments.

In Europe, the latest budget has been boosted further by the NextGenerationEU Recovery Fund, which amounts to a €1.8 trillion stimulus designed to generate a greener and more resilient post covid-19 EU, with 30% set aside for fighting climate change.3 In the US, President Biden has unveiled a $2 trillion infrastructure plan to ‘Build Back Better’, which includes proposals to modernise the electricity grid, support the transition to electric vehicles, improve the energy efficiency of homes and schools whilst offering tax credits for clean energy generation.

Maintaining the required momentum and associated expenditure will require unwavering, co-ordinated support from Janet Yellen and Jerome Powell (Chair of the Federal Reserve). Simplistically, they have the potential to print as much money as required at ultra-low interest rates, whilst also maintaining institutional credibility, for now.

There is no doubt that climate change poses profound challenges for the global economy and certainly the financial system” Jerome Powell  With both Yellen and Powell increasingly vocal about the climate crisis in recent months, we think it is likely another stepping stone along the road to ‘modern monetary theory’. Yellen even seemed to hint at this on her own Twitter feed last month, stating “It is the time to recommit our government to playing a more active and smarter role in the economy. The Administration’s planned actions are not fiscal stimulus in the way we have seen in the past.”
RUNNERS NOT SPECTATORS

In addition to the heavy lifting conducted by governments, the private sector will need to play an important role with significant investment required in both climate adaption and mitigation.

At Ruffer, this transition presents us a range of investment opportunities in areas such as e-mobility (the subject of the previous quarterly report) and power generation. However, this is a marathon, not a sprint and one must tread carefully to avoid pitfalls: MSCI recently reported that stretched valuations and sentiment have resulted in the clean energy sector becoming the most crowded market segment on record with the exception of tech stocks during the dot-com bubble.4

In addition to the danger of overpaying for hot (green) air, the transition presents several other investment risks. The most obvious ‘transition risks’ relate to changes in public policy, taxation and consumer preferences. A widely used, consistent carbon price (either as a tax or implemented through a carbon trading scheme) would have a dramatic and immediate impact on business profitability and not just in the most obvious sectors. Combatting climate change has the potential to introduce significant monetary instability into the financial system. New technologies and automation (impacting wages) in the longer term are likely to drive deflationary forces, but the shorter-term impulse is likely inflationary. This is not only due to the scale of newly printed money needed to finance the climate transition, but also as companies adapt by shortening and greening their supply chains, whilst simultaneously looking to reduce the carbon intensity of their products and services, with consumers also willing to pay a higher price for ‘green’ credentials. Ruffer portfolios are well positioned to protect against inflation.

Depending on the nature, speed, and focus of these changes, transition risks will pose varying levels of financial and reputational risk to organisations. How President Biden and his international peers approach these issues will be critical, but how we approach them is crucial, too. Being able to analyse exposure to these risks will be key to achieving our aim of capital preservation. Climate risk and public policy development is, therefore, something we are closely monitoring, not just in relation to listed equities, but across other asset classes, too. As an example, we have recently developed a proprietary sustainability rating model for government debt (more to follow in a subsequent quarterly report) and have been actively researching a range of alternative assets that have potential to protect or benefit portfolios as climate policy becomes further entrenched in the years ahead. 

2021 Q2 report
In our latest quarterly report, Investment Manager Rory Goodman examines the global significance of US President Joe Biden's new emission reduction targets announced at the Earth Day summit, and we share our stewardship and engagement activities during the second quarter of 2021.
Read
Climate Change Framework 2021
Our inaugural TCFD Report introduces Ruffer’s Climate Change Framework and provides a response to the recommendations of the Taskforce for Climate-related Financial Disclosure. The report exhibits our climate-related activities over the past few years and provides an insight into how our understanding of the risks facing our investee companies has evolved.
Read
Annual Stewardship Report
Our 2021 report highlights the depth and breadth of our stewardship activities. Our focus on engaging directly with company management has afforded us a deeper understanding of the companies in which our clients are invested.
Read
  1. Climate Action Tracker
  2. One Earth
  3. European Commission
  4. MSCI

Past performance is not a guide to future performance. The value of investments and the income derived therefrom can decrease as well as increase and you may not get back the full amount originally invested. Ruffer performance is shown after deduction of all fees and management charges, and on the basis of income being reinvested. The value of overseas investments will be influenced by the rate of exchange.

The views expressed in this article are not intended as an offer or solicitation for the purchase or sale of any investment or financial instrument, including interests in any of Ruffer’s funds. The information contained in the article is fact based and does not constitute investment research, investment advice or a personal recommendation, and should not be used as the basis for any investment decision. This document does not take account of any potential investor’s investment objectives, particular needs or financial situation. This document reflects Ruffer’s opinions at the date of publication only, the opinions are subject to change without notice and Ruffer shall bear no responsibility for the opinions offered. Read the full disclaimer.

London
80 Victoria Street
London SW1E 5JL
Edinburgh
31 Charlotte Square
Edinburgh EH2 4ET
Paris
103 boulevard Haussmann
75008 Paris, France