The Climate Case
The theory of efficient markets says that all stock prices are perpetually accurate, because all investors always have complete and up to date information about all their holdings. But as any casual observer can tell you, information and topical awareness are not evenly distributed, even among professional analysts. Reality is always far more complicated than equity markets can quickly or easily assimilate, meaning information asymmetry is a constant. While information asymmetry is usually considered a type of market failure because it can lead to adverse selection of products, services or financial instruments, it is also well known to be and frequently used as a “source of competitive advantage.” The person with the most information is best equipped to make the best investment decision.
The good part of this is you don’t need to be an insider or possess secret information to benefit from information asymmetry. There are tons of key but underutilized data out there for anyone willing to put in the reading time.
So what information, currently largely overlooked in financial markets, can we exploit for long-term gains? One enormous area of unequally shared data hiding in plain sight is climate and environmental information. A recent MIT Technology Review article, “Global Warming’s Worst-Case Projections Look Increasingly Likely,” sums up the information divide well: “Various politicians, fossil-fuel interest groups and commentators have seized on the uncertainty inherent in climate models as reasons to doubt the dangers of climate change, or to argue against strong policy and mitigation responses,” yet science’s best and most-recent data show that, “simulations that turned out to most closely match real-world observations of how energy flows in and out of the climate system were the ones that predicted the most warming this century.” There’s a big disconnect there, and market inefficiencies do result.
One reason that asymmetric climate knowledge exists is misinformation or even disinformation. As long as industries, companies and their mouthpieces have been able to benefit from telling people something other than the truth, they have tried to do so. Often, they have succeeded in misrepresenting reality very successfully. Take the famous example of ExxonMobil. A 2017 Harvard study confirmed previous findings that ExxonMobil deliberately misled the public about human-caused climate change. The vast majority of ExxonMobil’s own research included commentary that climate change is real and human-caused, while an equal percentage of their advertorials (editorial-style advertisements) expressed doubt. Their efforts at disinformation have been serious enough that the attorneys general of Massachusetts and New York are investigating ExxonMobill for misleading investors when it communicated, and didn’t, about climate change risks. The legacy of this misinformation campaign continues, as made perfectly clear by the number of Americans who disagree that human activity is the primary drivers of present day climate shifts.
That’s not to say that being on the more informed side of asymmetry results in perfect information. The MIT Technology Review article concludes that, “an emerging challenge is that the climate is changing faster than the models are improving, as real-world events occur that the models didn’t predict. Notably, Arctic sea ice is melting more rapidly than the models can explain, suggesting that the simulations aren’t fully capturing certain processes.” Even those of us trying to get a handle on the situation may be underestimating the reality of its magnitude, and thus still not making optimal portfolio decisions.
It isn’t just climate misinformation that produces information asymmetry, but also understatements about the speed with which change is occurring, in terms of both the climate itself and climate-mitigating technologies. It’s no coincidence that three of the world’s largest solar PV manufacturers have been taken private or have planned to go private in the last year, since their share prices were demonstrably undervalued relative to their fundamentals, and they are simply buying back their shares at ridiculously low prices. The companies taking themselves private are taking advantage of the asymmetry.
A leading scholar on the dynamics of navigating the transition to a low carbon economy, Auke Hoekstra, explains how many energy industry projections continue to underestimate the pace of these changes: “The energy domain is still dominated by equilibrium models that underestimate both the dangers and opportunities related to climate change. In reality, climate and energy systems contain tipping points, feedback loops and exponential developments.”
Hoekstra addresses the economic dimension of this climate information asymmetry in plainer language on Twitter: “Climate change is expensive, so avoiding it, is sound economics…This is what many economists and older politicians/voters don’t seem to grasp…If you take a really hard look at the estimates of scientific experts on climate change instead of economists (economists are not experts on climate change…) and you input that into economic models, we should be working like crazy to phase out fossil fuels…And if you tried to put a price on the insurance premium that we should be willing to pay and you asked the insurance experts to determine that and you would put that into the economists’ models, the importance goes [off] the chart…That’s really not a political opinion. It’s an outcome of economic modelling. And that might be good to know.” For an equity investor, that is definitely good to know. It provides a fantastic indicator of where economic growth is likely to occur in the global economy.
For investors, bridging the asymmetry gap depends on reactions to information, not just awareness of it. For example, how is the automotive industry evolving in the presence of changing climate, and how does an investor respond? According to Navigant Research, governing officials announced that India plans to sell only electric cars by 2030, which is a major goal for the third-largest polluting and second-most populous country in the world. France and the UK have announced bans by 2040. China has announced a ban, but with no definite date. How do we react to this? These clear and present trends hiding in plain sight mean big things for future oil demand and also for the value chains of renewable energies and zero emissions transportation. We know that electric vehicle demand is increasing, electric and autonomous vehicle technology are rapidly improving and becoming much cheaper, and storage technology and infrastructure systems are growing. India’s and China’s regulatory tailwinds may just expedite the transition. By triangulating facts from a wider range of angles—scientific, technological, economic, political—we can hone in on some pretty clear opportunities. There are huge growth stories available to those willing to engage with an expansive body of data. And these data largely (though not exclusively) begin with cognitive assimilation of climate science.
We don’t need to rely on policy models to make judgments. We can see these trends unfolding worldwide now. As David Roberts of Vox explains, broad averages can often conceal “leading wedge markets,” regionally specific markets where a particular industry (such as solar) scales up faster and drives down costs in other markets. Analysts who only examine a broad, national statistic like “levelized cost of energy (LCOE),” may miss the boat if they take such estimates at face value. Not only can major systemic change cause differing levels of informational awareness, but the rapidity of that change can create knowledge discrepancies as well. Examining the details remains important.
One more place where change data is lacking is in some analysts’ exclusive focus on quarterly reporting, as opposed to a focus on longer-term value creation by modelling, planning for and seeking to invest in leaders of the future. This is true with investing in general, but has particular valence with respect to climate change informational asymmetry. Climate change mitigation will become more and more important, and therefore a larger and larger part of the global economy over time. For example, solar power is in all likelihood growing from providing 1 percent of the world’s electricity generation in 2015 to 50 percent by 2050. Taking a longer-term view and placing less emphasis on quarterly results could empower an investor to invest now in companies working to position themselves as global energy leaders of tomorrow, and reap the benefits as they grow along the way to that goal.
These and similar observations have not gone entirely unmade within investment management. In their white paper (reg. required) “The Good Thing About Climate Change: Opportunities,” Lucas White and Jeremy Grantham write: “We think current growth projections are likely to dramatically understate realized growth as the world continues to mobilize to address climate change and costs continue to fall for clean energy solutions…We believe that the climate change sector is likely to be a particularly inefficient sector and that a disciplined value orientation will be key to harvesting strong returns.” The “climate change sector” is “particularly inefficient” because of the huge information gap.
Why, then, aren’t more people integrating climate information asymmetry into their portfolios? The answer, of course, is that it’s not easy. Doing the work to exploit info asymmetry is a real commitment. Many people, being time and attention constrained, find it convenient to rely on other analysts’ coverage of a stock or simply look at a rating or estimate rather than conduct their own research or begin from fundamentals. For the average investor, this is understandable. For the portfolio manager, this is laziness that results in an opportunity lost at best and mismanagement of risk at worst. This is partially what drives herd mentality in stock markets, where everyone is citing the same reports and opinions.
As long as there is differing awareness, understanding and application of available information, there will be inefficient markets we can exploit for returns. Many scarcely believe that. We’ve lived under the shadow of efficient markets theory and indexing for so long that we’ve forgotten what full sunlight might look like, and we’ve forgotten that it’s even possible to take advantage of inefficient markets. So, as always, we urge you to assimilate everything you see around you across disciplines and industries, think about where the global economy is and where it is most likely to be growing. Use the information you know, don’t rely on facile “buy” or “sell” ratings and, stock-by-stock, apply that knowledge to building portfolios of assets focused on what’s next. As a consequence, you’ll be able to forget about owning the declining market shares of what was. Ideally, you can do all that while respecting Grantham’s advice to employ rigorous value discipline.
The person with the most information is most well equipped to make the best investment decision; so how can it be less advantageous to be working from a unified theory of the totality of economics? Increasingly, given the pace of technological advancement and the daunting scale of our globally systemic risks, forward economics looks like what we at Green Alpha call Next Economics, what White and Grantham call the “climate change sector” or, more generally, what we all refer to as sustainable economics. And by “sustainable economics,” we mean the only economics available to us going forward if we want the global economy to thrive indefinitely. This is where investment opportunity can be found, even if—and especially because—not everyone gets that.