Climate inflation comes for us all

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💡This week: Investors who still think of climate change as a niche investment theme instead of a fundamental across-the-board risk should take a look at GIC’s latest annual report.

The Singapore sovereign wealth fund reiterated its view that inflation will be more persistent over the longer term. One of the key reasons cited is the “rising cost and demand-led inflation associated with the green transition”.

Furthermore, there will be a “significant need to invest more in energy and climate change adaptation across countries, businesses, and households to become more climate change prepared, over and above the investments required for a successful green transition” given the expected damage from climate change, GIC said.

In other words, climate change creates a structural drag on everyone’s investments.

GIC cited the work of German researchers who have worked out the near-term impact of climate change on economic cost and inflation. In a paper, Maximilian Kotz, Anders Levermann and Leonie Wenz calculated that the world is already set on a path to lose 11 per cent to 29 per cent, or US$19 trillion to US$59 trillion, of global GDP by 2050 due to climate change. The estimates are based on economic productivity, labour and agricultural productivity.

Importantly, these estimates show “committed” losses, which means that they apply regardless of future emission choices until mid-century. That is because there is a lag between decarbonisation choices and economic impact; these losses are sown from seeds already planted.

The loss estimates are also likely to be on the low side. The study did not include potential channels of climate damage such as heatwaves, sea level rise, tipping points and non-market factors that include human health.

Kotz also co-authored another paper, with fellow researchers Friderike Kuik, Eliza Lis and Christiane Nickel, that looked specifically at the inflationary impact of global warming. The group found that projected temperature increases for 2035 will likely lead to an additional 0.92 to 3.23 percentage points of food inflation per year, and to an additional 0.32 to 1.18 percentage points of headline inflation per year on average globally. The impact is more pronounced in tropical regions.

The implication of those studies is that the economic cost of climate change is significant, wide-ranging and unavoidable.

That cost matters to GIC, which is tasked by the Singapore government to invest for the long term to preserve and enhance the international purchasing power of the funds that it manages. Those funds include Singapore’s foreign reserves and pension money committed under Singapore’s Central Provident Fund programme.

A key metric for GIC is the long-term real rate of return of its portfolio, which on an annualised rolling 20-year basis declined by 0.7 percentage point to 3.9 per cent in the year ended March 2024. Because GIC invests globally, an increase in global inflation makes it more difficult for the firm to deliver on its mandate.

Persistently elevated inflation could mean that GIC might have to accept a lower baseline rate of return, but this would not be good news for Singapore, which relies on the reserves not just to defend its currency but also to boost the size of the fiscal budget. GIC could also take on higher risks to maintain its rate of return, but its ability to do so is limited by the capital preservation part of its mandate.

It’s therefore perfectly rational that GIC has dedicated platforms to finance climate mitigation and adaptation, and actively engages with portfolio companies on sustainability issues. After all, limiting global warming is good for GIC’s portfolio.

One might think that GIC, with its massive portfolio and national purpose, isn’t like most investors, but it’s still exposed to the same market forces as the rest of us. Anyone with bonds in their portfolio and anyone trying to save for retirement struggles to beat inflation. It’s bad news for everyone if inflation stays high.

Assessing climate resilience and impact isn’t something meant only for the climate-themed allocation of a portfolio. It’s material to the entirety of a portfolio and should be a core consideration.

🌱Top ESG reads:

1. ESG factors in the investment process can drive commercial returns and improve risk management, says Temasek sustainability managing director Park Kyung-ah.
2. Only 16 ESG funds launched in May 2024, the lowest monthly count since the start of 2020, amid a pushback against sustainability-themed investments.
3. Private equity manager Seraya Partners has acquired Australia-based vessel operator MMA Offshore at a A$1.1 billion valuation.
4. Power generators at the Singapore Formula 1 race emitted about 40 per cent less greenhouse gases in 2023, says event organiser Singapore Grand Prix.
5. Companies need to prepare for the “just-in-case” costs of building resilience against global challenges, says Singapore Senior Minister Teo Chee Hean.

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