Climate change and artificial intelligence (AI) are two ‘supertanker trends’ that pose significant risk to asset allocation according to a new report from BNY Mellon Investment Management and CREATE-Research.
The report found 89 per cent of the institutional investors with combined assets under management of over £10trillion regard climate change and AI as investment risks. Almost all – 93 per cent – view climate change as an investment risk that has yet to be priced in by all the key financial markets globally, while over 85 per cent view AI as an investment risk that could potentially provoke societal backlash as well as geopolitical tension.
Over half – 57 per cent of the respondents view climate change as a risk and an opportunity, while 36 per cent view it as a risk only and 7 per cent view climate change as an opportunity only. The report argues investment specific challenges related to climate change centre on areas that are unknowable, requiring judgemental calls about the future. Factors include low progress on carbon pricing – envisaged under the Paris Agreement – which is leaving investors guessing at what point draconian governmental action will become inevitable, and the dilemma on the future of stranded assets, with investors weighing up whether to mitigate investment risks now or later at potentially higher costs.
The report also argues engagement with carbon emitters is more difficult for investors in fixed income than equities, with fewer opportunities to engage with companies via voting rights or annual general meeting attendance.
The report found that in response to the challenges arising from climate change, investors are factoring in the potential for draconian measures, ensuring they have intensive engagement with companies, increasing investment in green bonds and accepting ESG as a risk minimising tool.
It found 52 per cent of the investors surveyed, who stated AI was a risk, also regarded it an opportunity, whereas 33 per cent saw it as only a risk and 7 per cent regard it as an opportunity only.
The report argues the rise of AI creates four investment specific challenges – corporate lifecycles will get shorter as AI creates winners and losers, as shown by the impact of the earliest versions of the iPhone on Nokia in 2007; sectoral boundaries will blur, as AI reconfigures entire products, as seen with Tesla, which straddles multiple sectors, causing valuation issues;onshoring of manufacturing activities will diminish the prospects of emerging economies, with 3D printing shifting the geographical centres in global supply chains; ad intangible values of companies will be enhanced in ways that are hard to measure for asset valuation purposes.
In response to these challenges, investors are increasingly mixing active and passive investment strategies, focusing on idiosyncratic risk in portfolios, targeting emerging innovation leaders and blending hard and soft metrics in their analysis, the report concludes
BNY Mellon Investment Management global head of distribution Matt Oomen says: “The best opportunity is rarely the most obvious one. For investors caught up in the day-to-day maelstrom of constant change, choosing the right path can be difficult. Compounding these challenges are large secular trends, such as artificial intelligence and climate change. Already we are witnessing a change in the way markets operate in response to these two supertanker trends. These will be the defining challenge not just for the current generation of asset managers and investors, but for generations to come.”
BNY Mellon Investment Management chief executive officer Mitchell Harris says: “The study highlights two shifts that stand out within asset allocation – the move from active to passive and from public to private markets. Both are indicative of the reincarnation of the old core-satellite model. We believe passive will be raising their share of core assets, while active will be focusing on satellites that dominate either inefficient or illiquid markets. The separation of alpha and beta is structural but the two styles of active and passive investing will remain interdependent.”
CREATE-Research project leader Amin Rajan says: “Newly emerging investor segments see a clear distinction between product alpha and solution alpha – beating the markets via stock picking versus meeting investors’ predefined financial goals and personal values. Today’s asset management industry may well be unrecognisable by the end of the next decade in the face of mega trends. Success is about navigating through the fog to create a new future, far removed from old connections and causality.”
