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rethink everything

Rethinking the risks of the climate crisis

LOcom_AuthorsAM_Minio-Paluello.png   Carolina Minio-Paluello
Global Head of Sales and Solutions 
Lombard Odier Investment Managers


According to Jean-Claude Junker, President of the European Commission, we would need around four planets to maintain our current lifestyle. Unfortunately, we only have one. And when you consider that the global population is expected to grow by another three billion people over the next thirty years, we clearly have a very big problem.


More with less

The population has already trebled since the 1950s. And as people have become healthier and wealthier, they require not just more food, but also more protein-based food. In response, meat production has gone up 600%1. According to the US Department of Agriculture, the average American will eat a record 101 kilos of red meat and poultry this year.  The World Economic Forum forecasts that by 2050, meat production will have increased by a factor of ten since 1960.

But meat production is something of a vicious cycle. Demand for meat is already pushing the planet well beyond the level it can sustain. How will we cope if demand for meat and protein doubles, as expected, over the next 30 years?

Since the 1980s growth in beef production, for example, has slowed. The number of cows on the planet peaked at just over 1.1bn in 1989 and is expected to be just shy of 1bn for 20172. In part, this is because factory farming, which was believed to be more efficient than grazing, is, in fact, highly inefficient.
 

Roughly a third of all the grain produced in the world is fed to livestock – that’s enough to feed four billion people.


The expansion of agricultural land is already putting enormous pressure on natural resources such as fresh water, forests and oceans, as it contributes to deforestation, soil erosion and marine pollution. According to the University of Sheffield’s Grantham Centre for Sustainable Futures, the world has already lost a third of its arable land over the last 40 years.
 

So where are we going to grow all the grain and put all those animals to produce twice as much protein in 30 years?


But it doesn’t stop there. Land-based meat production and associated agriculture is also affecting our ability to get protein from alternative sources. The meat industry has already been blamed for creating the largest ever ‘dead zone’ recorded in the Gulf of Mexico as toxins from manure and fertilisers pollute waterways. These pollutants encourage plumes of algae that deprive huge stretches of the ocean of oxygen, killing marine life, or forcing it to move elsewhere. This is a serious problem if people are thinking fish is a potential (and healthier) replacement protein source for beef.

To add insult to injury, livestock are also significant contributors to climate change because of the sector’s high greenhouse gas emissions and factors like deforestation. As the world warms up, water levels rise and droughts become both more common and more severe, our potential to provide enough protein becomes even more restricted.
 

Essentially, our approach to meat and its production is creating a self-perpetuating danger to global food security.


Sustainability – the foundation of long-term investment returns

So what has all of this got to do with investment portfolios?

Simple. Risk.
 

The agricultural sector will have to change. The companies that operate within it will have to increase their efficiency massively if they are going to control costs, protect profitability and provide shareholders with returns over the long-term.


Can you just avoid agri-business?

Not really. As the number of global challenges mounts, there are fewer and fewer places to hide. Factors like demographic changes, scarcity of natural resources, climate change, inequality and the rapid advance of technology will have a transformative effect on most companies, sectors and, ultimately, our economies in the coming years and decades.

And change is coming fast.
 

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Governments globally are responding with increasing urgency to the climate crisis, for example. Two decades might sound like a long time, but when you’re talking about reshaping several industries and national infrastructure systems, it’s not very long at all. And the faster they have to change, the greater the chance of shocks along the way.

Consider the impact, for example, of the move to phase out cars with internal combustion engines by 2040 in countries including the UK, France, India, Norway, China and the State of California. The implications for today’s auto manufacturing industry are profound.

Automakers are already scrambling to secure supplies of lithium to make batteries for electric vehicles. But lithium supply is not keeping pace with growing demand. Prices for lithium carbonate, used in the cathode of a battery, doubled between 2015 and 2017 and experts have warned of a ‘supercycle’ that could push prices up much higher. Which car companies will be able to secure the best prices? Which will struggle to maintain growth if they can’t secure lithium at reliable forward prices? How will independent producers fare against national giants in the battle to secure supply?

But the impact of this one regulatory initiative will not stop there. Suppliers to car manufacturers and dealerships will be affected. So too will service stations and homes across those nations as new charging points have to be installed, and old diesel and petrol pumps will need to be decommissioned and disposed of. And all that electricity has to come from somewhere somehow.
 

A change of this magnitude throws up risks and opportunities for companies across many different sectors and those who struggle to adapt and transition, could find themselves being penalised by equity and debt markets alike.


This is just one example of how sustainability challenges are forging a closer link between companies’ social and environmental practices, and their stock valuation.


Rethinking business models

Given the scale of change underway, we believe investors have to ask themselves a few fundamental questions:

  • Are sustainability factors driving economies today and in the future?
  • How fast is the transition likely to happen?
  • Are companies preparing themselves to transition in an orderly fashion?
  • And what can investors do to make sure that happens to avoid shocks in their portfolios, and leverage opportunities to generate sustainable risk-adjusted returns?

As long-term investors, our job is to analyse which sectors will win and which will lose, which companies (and countries) are adapting and innovating, and which are run in a sustainable fashion. We then have to take that information and integrate it in how we build our whole portfolio.
 

After all, sustainability is a multi-sector, multi-asset class, multi-jurisdictional issue. It does not belong in only one, small part of a portfolio, but across the whole spectrum of investments.


At Lombard Odier, we believe sustainability is a fundamental building block of economic growth and of long-term investing. As a result, integrating sustainability in any and every investment process is becoming increasingly important.

We call this process responsible investment.

1 Earth Policy Institute
2 USDA, World Cattle Inventory

Important information

This document is issued by Bank Lombard Odier & Co Ltd or an entity of the Group (hereinafter “Lombard Odier”). It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a document. This document was not prepared by the Financial Research Department of Lombard Odier.

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