According to evidence posted on NASA’s climate change website (http://climate.nasa.gov/), the rise in earth’s surface temperature comes at a time when the sun’s energy (which reaches earth) isn’t rising.

How does it matter? As climate patterns change, crop cycles can get altered. It gets hotter and risks of draughts, floods and heat waves go up. All this leads to damaging life and living conditions.

This article, however, isn’t about the impact of global warming and climate change, but how this impacts fund managers.

Excess emission of carbon dioxide is one of the main reasons cited for global warming. A lot of this is due to manufacturing activity, use of machines, and automobiles.

As a result, in many countries there are regulatory restrictions on production and manufacturing activity of specific industries. Also, clean energy companies are taking up some of the incremental market share from traditional energy generators. Do these factors influence fund managers’ stock selection since this can impact profitability? Mint spoke to a few domestic fund managers to understand whether it matters or not.

Effect on companies

Increasing evidence of global warming and climate change patterns has resulted in certain regulatory processes when it comes to setting up and maintaining industrial units. To that extent, there are risks that companies face on costs and on long-term sustainability of operations. For example, a carbon tax is applicable on certain manufacturing activities in many European countries based on their carbon output. “Basically, we consider these as part of operating costs while building in earnings forecasts. High costs can reduce profitability and make an investment unviable.” said Gopal Agrawal, chief investment officer, Mirae Asset Global Investments (India) Pvt. Ltd. For example, domestic airlines flying on overseas routes have an additional carbon cost attached which should be considered in the cost analysis. Overall, experts suggest that such costs at present are not more than 5% of the total costs.

India has a form of clean energy cess on coal producers and importers, which was doubled last year to Rs.200 per tonne. There are also excise duties on petroleum products, which acts as a disincentive to overuse as it makes the fuel costlier (but the intent is to cover the fiscal deficit rather than care for the planet). These kinds of taxes and duties add to costs, and eventually, if cost is too high, it can impact price and drive down demand.

“Overall, it does matter. If you see, there are certain industries like forging and casting which are globally considered unviable due to these reasons; hence, the production is shifting to countries like India which cater to European and US markets.” said S.N. Lahiri, chief investment officer, L&T Investment Management Ltd. Due to norms in Europe and the US, compliance costs for these industries on upgrading technology and adhering to emission norms has gone up and buyers look for lower cost suppliers. In this example, the shift is merely geographical. However, electric cars and other battery charged vehicles or solar powered homes are now a reality that one can’t ignore. These developments are happening at a faster pace with changing climatic conditions.

Compliance and litigation costs feature in financial forecasting models that fund managers use to arrive at an appropriate price to pay for a company’s stock. In India, too, the Central Pollution Control Board prescribes environmental standards and emission norms. Compliance is needed to get relevant licenses.

“A lot has changed in manufacturing plant operations when it comes to aspects like adherence to pollution norms, water treatment plants and so on. There is a need to follow regulations which are evolving,” said Lahiri.

The rural economy, too, can’t be ignored. Agrawal said there is a major impact on rural economy as weather patterns are getting altered and this needs to be understood better. As part of research, Mirae Asset tracks commentary from Australian Weather Department to be informed about El Nino patterns.

New product lines

Traditional companies need to think about loss of market share to options that focus on renewables. While the pace is slow at present, in pockets, small industries and housing complexes are focusing on using renewable sources.

The change is perhaps best witnessed in the global automobile industry. As per data from Hybridcars.com, in Norway, the market share of plug-in electric vehicles was 22.39% in 2015, up from just 13% in 2014. Norway is a leader in this segment in terms of market share, but elsewhere too, the number of registrations are increasing. In the US, there are a total of 411,120 (as of 2015) highway-capable plug-in electric vehicles registered, up from 291,332 at the end of 2014. These numbers include both utility vehicles and passenger cars.

The share (global) is still insignificant given the growth of the industry, but the trend has grown at a much faster pace (globally) in the past five years.

Impact on stock selection

At present, there isn’t much of an impact when it comes to the simple stock selection process. Estimates are built into cost and if even at the higher cost base a company looks attractive to add to a portfolio, it is added. There is little else by way of quantitative factors to assess the long-term impact of lower pollution standards. Hence, companies aren’t left out simply because they pollute and cause damage to the environment. But it is acknowledged that climate change can impact a business’ sustainability.

“We work within a defined environment, social and governance (ESG) framework. After factoring in ESG, we consider whether the risk is worth taking. Over the years, fossil fuel-based products will get redundant. So, we question whether our investment will get affected or disrupted by better technology.” said AnandRadhakrishnan, chief investment officer, Franklin Equity, Franklin Templeton Investments India.

Most fund managers we spoke to said it is too soon for a complete change in thought process around stock selection as companies are not yet proactively embracing pollution reduction objectives (beyond regulatory requirements). Fossil fuel remains the cheaper alternative, especially for large manufacturing plants. Plant load factor or the average energy produced divided by peak production for, say, a windmill is much lower than for a thermal power plant. Lastly, for solar and wind energy, a lot depends on external factors, which are beyond control. Power storage for solar is yet another area that needs development.

“In a growing economy like India, the willingness and incentive to embrace a change like shifting to renewable energy is some time away. Other matters tend to take priority,” said Radhakrishnan.

All these factors mean odds are still in favour of fossil fuel usage and no significant change in consumption patterns based on the threat of climate change is envisioned soon. Hence, stock selection based only on these factors generally impacts a very small percentage of most diversified equity fund portfolios.

“In our conversations with companies there are some interlinkages with such issues. But there is more emphasis at the moment on social and governance framework. The environmental framework is still voluntary,” said Radhakrishnan.

For fund managers this means they might have to initiate the dialogue. Those who are able to identify the change in trend away from fossil fuels early and build it into stock selection will benefit the most (at the moment there isn’t much of a selection in listed equity). At present, the chips are down for the energy sector, which might be an opportunity for renewable energy companies to pick up market share. If they succeed, selectively, this can leave market capitalisation of large energy stocks wanting for a longer time than anticipated.