I am currently serving on the World Economic Forum’s global future council for investment. The council has set itself the task of offering up thoughts to describe aspects of the likely 2040 portfolio. In this post, I offer two thoughts regarding the (possible) reshaping of the macro landscape that will exist in 2040, and within which the portfolio will need to be built. As the future is impossible to forecast, all the usual caveats apply.
Climate change is a useful anchor
I start from the concept in which I have most confidence, that the climate is changing. I believe this is now widely-enough accepted that we will see material changes over the next two decades, as we collectively seek to adapt the global economy. The current scientific consensus is that we need to have completed our second halving of emissions by 2040. Let that thought sink in for a moment. The global economy needs to be emitting no more than 13.5 billion tonnes of carbon dioxide equivalent in 2040, compared to our current 54 bn tonnes[1]. The scale of the transition required is hard to imagine.
From here, we can follow two threads: one sensible, the other more speculative.
The sensible thread
This scale of decarbonisation implies that, by 2040, we will have made considerable progress in converting the world’s energy supply to renewables. In fact we might be about 2/3rds of the way through our energy transition programme, having spent $75trn by 2040[2]. This represents both good news and bad news. The good news is that this represents a copious supply of high-quality assets that can absorb all those defined contribution pension contributions. The bad news is that the high-quality product (carbon-free electricity) close-to-guarantees strong demand … and therefore low investment returns. Hold that thought for a moment.
The speculative thread
Most investment folk have spent most of their career thinking solely about financial capital. It is only recently that multiple stakeholders and multiple capitals have started to encroach on the investment mainstream. To simplify, let us assume there are two types of capital – financial and natural – and that 250 years ago financial capital was very scarce while natural capital was abundant. On that basis, what would you expect the 250-year returns to be on the two capitals? But we are in the present looking forward 20 years. What returns should we expect on financial capital, now that it is abundant? Government bonds being issued at negative yields suggests the “risk-free” rate is pretty low. Should we expect this to increase?
And what returns might we get from natural capital now that it is scarce? Mark Twain was ahead of his time when he said “buy land, they’re not making it anymore” (well, not at scale). In 2040 we will need to feed an additional 1.4bn people. Some of the solar and wind farms will need to be built on land. The earth will be hotter, so we might be losing liveable and farmable land in some parts of the world. And we should be preserving, if not expanding, our forests. In sum, if we proxy natural capital by land, there appears to be strong demand for it and its services over the next 20 years. Could a scarce capital, in strong demand, yield attractive (financial) returns?
Our problem is bigger than climate change
We are building a thought experiment to explore the world of 2040. So far we have invoked climate change to suggest some likely changes. However, carbon in the atmosphere is just one of the nine planetary boundaries identified by Johan Rockström[3]. Our bigger problem is that our linear economic system (take-make-use-throw) isn’t long-term sustainable on a finite planet[4]. The relevant question here is whether this matters within the timeframe we are considering – in building our 2040 portfolio we are probably looking out to 2050 at least. Will we have started to transition to a circular economy within that time? If we have, then we need to add yet more profound change on top of our climate transition.
In fact, a circular economy is arguably more problematic for the investment industry than transitioning to zero-carbon. By definition, a circular economy is about disrupting or replacing the linear economy, meaning the through-put of consumer goods is considerably reduced. It is about, for example, transport-as-a-service and therefore lower annual automobile production (and electric vehicles have far fewer moving parts, so can remain in use longer). It is my belief that a circular economy is less (financial) capital-intensive, and therefore reduces the size of the opportunity set for the investment industry (the variety could increase, but the corporations might be smaller).
The lay of the land in 2040
Our two thoughts prompt two important questions for investors to consider: (1) will we be a significant way through the necessary transition to clean energy? And (2) how significantly will we have transitioned into a circular economy? While important, these questions are far from complete. In this post we have not considered the likely shape of government finances 20 years hence, nor demographics (the ‘gravity’ of economics), geopolitics, and technology. And we have not overtly considered the functioning and evolution of the overall economic system. To properly explore the possible landscape of 2040, we would need to consider all these issues, their inter-relationships, and concepts such as path dependency and non-linearity – and that requires more space than a blog post allows.
Instead, let’s return to that thought we held – the likely low returns on building clean energy capacity. If we believe the capacity will be built, then the investment industry will end up with exposure to it. It will either be downstream because it is built by companies we own, and financed by banks we own, or it could be upstream via direct infrastructure investment. And, if there is a rebalancing away from financial capital to natural capital, those low returns could be better than the alternative?
The future is unknowable. And yet, I have constructed the thoughts above as if some aspects of it can be known – that we will be 2/3rds of the way through our energy transition, and that the transition to a circular economy will have started. If these are not true, then we will be on a path towards a future I am not yet ready to contemplate. As the aphorism goes, the best way to predict the future is to create it. That is exactly what investment does – it allocates money now in the expectation of some benefit in the future. Our industry has the opportunity to change the world – OK, strongly influence how it changes. That looks pretty purposeful to me…
[1] The expectation for 2020 greenhouse gas emissions from exponentialroadmap.org is 54.2bn tonnes (version 1.5 updated March 2020)
[2] The International Renewable Energy Agency (IRENA) estimates that the cumulative investment required between 2016 and 2050 to transform the global energy system to meet the objective of the Paris agreement is $110trn (2040 is approximately 2/3rds of the time frame, and $75trn is 2/3rds of the total estimate). See the IRENA.org website
[3] A safe operating space for humanity, Johan Rockström et al, Nature 2009
[4] I have previously argued that past returns were overstated because the profits they were based on were overinflated, because we dumped our waste (degraded the natural capital) as an externality: https://www.linkedin.com/pulse/past-returns-arent-even-good-guide-tim-hodgson/