The recent movie Don’t Look Up is a timely reminder of how apparently far-fetched risks may grow exponentially, with dire consequences. Seeking early warning of such threats is not a new activity. In Roman times, the speculae or watch-towers were important infrastructure assets. From these vantage points, guards looked out into the distance, like today’s astronomers peering into space, seeking advance notice of peril to citizens. In that spirit, allow me to speculate on three dangers of growing importance for investors in the coming years.
The first relates to economic ‘indicators’ such as real GDP, currently considered a core barometer of economic performance. Its original value lay during the wartime era of the twentieth century, but it is less applicable today. Professor Diane Coyle from Cambridge University spells it out bluntly in Cogs and Monsters. She says real GDP “fails to reflect income distribution, omits valuable unpaid work, and ignores the environment”. In short, the signpost is now rusted and pointing in the wrong direction.
A focus on assets allows us to think about preserving them, a core tenet of sustainability.
Instead, investment attention will switch to balance sheet analysis when assessing the strength of economies. A focus on assets allows us to think about preserving them, a core tenet of sustainability. Thankfully, advances in technology have enabled us to make meaningful measurements of the state of natural capital assets that enhance our economic well-being. For asset allocators tracing the GDP cycle to make tactical bond and equity weightings, the change will re-write the rules, as GDP growth may simply be a veil for economic decline. For analysts, earnings estimates built off GDP forecasts will become unreliable signals of sustainable value.
The second risk is associated with the tragedy of the commons, whereby individuals acting in their own self-interest cause the depletion of a common resource – in this case, our common biosphere. The increase in greenhouse gases is one impact of this, but climate is just the start. According to the World Health Organisation (WHO), air pollution kills seven million people worldwide every year. Almost all of the global population (99%) breathes air that exceeds guidelines in terms of pollutants. Nearly half of us are living in water scarce areas for at least one month per year and, with urbanisation rates growing relentlessly, this could increase to over 70% by 2050.
According to the World Health Organisation (WHO), air pollution kills seven million people worldwide every year.
I believe the law will catch up with this, nationally and internationally, with material consequences in terms of corporate liability and stranded assets. For investors, the implication is to be overweight companies with pre-emptive green strategies rather than sticking with grey laggards. The old index fund argument that risk is minimised by holding a market-cap weighted portfolio of all assets (green and grey), has, like GDP, declined in relevance. It is based on an outdated mapping of risk, measured as volatility relative to an index, rather than to the real risks we face ‘on the ground’. When the map and the terrain give different pointers, trust the terrain!
The third and final danger I foresee lies in the tragedy of the horizon, or investment myopia. It manifests itself in increased market noise and a growing pre-occupation with chasing short-term security price movements. Especially in the current monetary policy environment, it only serves to increase price volatility and cause the deviation of prices from fair value. However, sustainable shareholder and societal value are both driven by longer-term cash flows. These are underpinned by trends in technology, consumer tastes, our values and innovation that change only slowly and require real insight to foresee.
The wise investor will, more than ever, heed the fundamentals, or delegate his savings to a similar-minded wealth manager. Investment research is set to become more valuable than ever – the clue is in the word ‘search’ – just as the diligent guard on watch, or indeed the sleepless astronomer.
A happy New Year and look out, not up!
Get Harold's Herald delivered to your inbox