Here's a super idea: use share choice for change

At the end of May industry funds supremo Garry Weaven gave Australia's $1.4 trillion superannuation industry a serve for failing to do their fiduciary duty and invest to avoid what he described as "irreversible, catastrophic climate change".

At the end of May industry funds supremo Garry Weaven gave Australia's $1.4 trillion superannuation industry a serve for failing to do their fiduciary duty and invest to avoid what he described as "irreversible, catastrophic climate change".

He used strong language, calling for radical action by super fund trustees to re-appraise asset allocation and stock selection, and to influence the behaviour of corporate Australia.

We are heavily exposed to climate risk, Weaven argued. "It is virtually certain that countries will point the finger at laggards and the powerful latent forces for protectionism will then translate into trade restrictions against countries with very high per capita emissions such as Australia."

Whether through inertia or a herd mentality, super funds are effectively betting against action on climate. If investors believed the world would act to limit warming to two degrees, they would immediately have to do a series of things (he listed eight), starting with writing down the valuations attributed to reserves of, and exploration rights for, fossil fuels.

While some funds were overweight renewable energy, "generally speaking no one in super has been prepared to take a root-and-branch approach to restructuring their investment strategy in line with the scientific facts of climate change and a judgment about the world's response.

"Few people would willingly support companies whose activities were demonstrably harmful to their children. So why in hell do we give so much support to those companies whose activities are clearly related to preventing governments from effectively addressing climate change?

"There is a lethal core of entrenched vested interests in Australia and around the world who choose to frustrate action and are prepared to enlist unprincipled politicians and, through intimidation, their own workforces in order to preserve the status quo. In this they are effectively aided by the many institutional shareholders who either support them or remain disengaged."

Fiery stuff from the former union leader. The problem for Australian investors is - what to do. Sell BHP and Rio to buy Infigen, Dyesol and Carnegie? In the current resources boom and in our thin sharemarket, pulling money out of fossil fuels virtually guarantees underperformance for years. Kiss those inflows goodbye!

Enter the London-based, non-profit Climate Bonds Initiative chaired by Sean Kidney, an Australian. The initiative aims to kick-start a new market in "green" bonds (loans to corporate and government borrowers, rated by credit agencies, bought by institutional investors and traded in debt markets).

For Kidney, bond markets are the key to raising the capital needed to decarbonise the global economy - which the International Energy Agency estimates will require investment of $US1 trillion dollars ($930 billion) a year for the next 40 years. To illustrate, Kidney and his team have worked out that, in comparable currency terms, that is three times more than was invested in the industrial revolution in the 19th century.

"This is the defining area of commerce for the next 50 years of our history, globally," he says.

Much of that investment will be in clean energy and transport infrastructure producing steady cashflows - like a solar thermal power station sitting in the desert with low maintenance and running costs. Decarbonisation, he says, "is a fixed-income opportunity because most of the assets required are going to suit fixed income investments".

Equity capital becomes the "foam at the beginning of a wave, that creates product and quickly dumps it into asset-linked bonds" held by big pension funds. Happily, in the wake of the financial crisis, pension funds worldwide - especially defined benefit funds trying to match foreseeable, long-term liabilities - are restructuring their investment portfolios out of equities and into bonds, which provide often-comparable long-term returns with much less risk.

The amount of capital shifting out of equities is huge. "We're talking tidal waves," Kidney says.

Worldwide, funds under management by global bond traders reached $US105 trillion last year and more than $US6 trillion of new bonds were issued. "The challenge of redirecting just 1per cent per year of funds under management into building the low carbon economy is eminently achievable," says Kidney.

About $US12billion of bonds backed by investments related to climate change solutions have already been issued internationally and Kidney expects that to hit $US20 billion within a year.

To make sure climate bonds stay "true to label", the initiative has established a climate bond standards board including the Australian Investor Group on Climate Change, the Carbon Disclosure Project and the Natural Resources Defence Council in the US. California State Treasurer Bill Lockyer is also there and the $US190 billion California State Teachers' Retirement System has just joined the board, which was likely to approve its first standard, covering loans to wind farms, at a meeting overnight. The first climate bond under the standard - some hundreds of millions, likely to be issued in Australia - is coming within weeks.

Similar international standards will follow on solar, biofuels, energy efficiency, broadband and so on. Initial support is likely to come from ethical or socially responsible investors starved of options in fixed interest for now, but ultimately Kidney hopes the climate bond market segment will grow big enough to be included in global bond indices used as benchmarks by big fund managers, in turn triggering more mainstream investment.

"The underlying premise is that there's enough institutional investors around that care about climate change, that if they're offered two products that have same risk-return profile - one brown, one green - they will choose the green."

The Climate Bond Initiative is investor-led for now, but Kidney thinks longer-term growth will be driven by concerted government action.

When governments "wake up" to the urgency of action on climate change, he argues, "they'll start doing what the US does and preference investments of all sorts, preference green investments. When things get really tough, we will start saying 'super funds need to shift a portion of their assets into climate change solutions - 1per cent this year, 5per cent next year'. But the deal will have to be, 'we'll organise the risk support to get you investment-grade returns'.

At that point an international accreditation scheme will be needed - perhaps, the Initiative will wind up attached to the UN - to allow super funds to meet those criteria.

Kidney thinks investing in climate solutions will become a "licence to operate" issue for pension funds, who enjoy guaranteed inflows and favourable tax regimes established by government.

"All these pension funds are floating on the back of a government scheme funnelling money into their coffers. Those guys getting paid a quarter of a million dollars to run a pension fund - or half a million or whatever they get - and their salaries depend on us, the voters, making a policy decision to throw money at them. That's fine, but it is an artificially-created pool of money and there has to be a licence to operate consideration - while ensuring our pensions are safe."

TWITTER: @gpaddymanning

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