Environmental Alpha
Oct 14th, 2009 | Filed under: Hedge Fund Industry Trends, Today's Post
Like Bo Jackson and others, Angelo Calvello is a “multi-sport athlete”. The early and outspoken advocate of portable alpha and originator of the term “alpha-centric” has now established his thought leadership credentials in the emerging field of green investing. He is the author of the forthcoming book “Environmental Alpha” (Wiley: 2009).
Calvello was one of several speakers addressing a standing room only crowd of nearly 400 people at Bloomberg’s New York headquarters at the inaugural CAIA Green Investing Symposium (organized by the New York chapter of the CAIA Association, and co-sponsored by the New York Society of Securities Analysts, the Connecticut Hedge Fund Association, and the Yale Center for Business and the Environment).
More than just a social issue, he describes climate change as the “mother of all investment themes.” In a refreshing departure from the usual (albeit important) socially-grounded view of climate change, he remained agnostic with regard to even the dirtiest of energy technologies (e.g. coal). Instead, he focused his remarks today on how to generate returns given the realities of climate change.
The drivers of those returns, according to Calvello, can be categorized as science, economics, policy, and technology. He divides “environmental investing” into 5 categories: clean technology, sustainable property, LULUCF (Land-Use, Land-Use Change, and Forestry), carbon, and water (although he acknowledges that water does not have a direct effect on green house gasses).
So what is environmental alpha? Although environmental investing may show potential for outsized returns in the future, it could all just be environmental beta. But Calvello argues that such a new field exhibits inevitable market inefficiencies. He points to the complex choice of a wind farm location as an example of the type of investment that relies on emerging and uncommon knowledge.
Reducing dirty energy use by 50% before 2050 (as global policy makers have discussed) would require about $45 trillion dollars – or about 1% of GDP per year. And that, according to Calvello is the heart of the investment opportunity.
“Backburner” no more
Rob McAndrew fondly recalls the heady days of 2006 and 2007 when carbon trading was the cat’s meow. But as he said today, “in the midst of a global economic downturn, it’s no surprise that carbon trading has taken a back burner.”
But McAndrew, the SVP of the Chicago Climate Exchange, is bullish again. He says his email is once again full of people wanting to know more about how to make money in the burgeoning market for carbon credits. He listed off a series of trading strategies used by players in this space.
With 35 billion tons of carbon being dumped into the atmosphere every year, he says that the global market for carbon credits could reach a few trillion dollars by 2020.
If 2009’s carbon auctions are any indication of the future direction of this market, this is no pipe dream. In June, the US Congress passed the “American Clean Energy and Security Act” that established the cap and trade system of carbon off-set credits. And with the EPA estimating that it will cost between $13 and $20 per metrics tonne to pollute, carbon trading looks set to go from “backburner” to “boiling over.”
In advance of carbon emissions becoming a tangible cost, some institutional investors have already begun to calculate the carbon footprint of their holdings (e.g. Sweden’s AP2 pension fund).
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I wrote a bit about some of the analytical considerations regarding climate change in “warming up the models” (http://researchpuzzle.com/blog/2008/07/03/warming-up-the-models). Part of what you see with some big firms leaving the Chamber of Commerce over this issue is that if you are creating models of the future you need to consider the probabilities and eventualities, which leads you to look at the regulatory landscape differently. It also results in different valuations on entities across a wide spectrum of the markets. That’s the part of all of this that hasn’t gotten enough play from the investment community.
Brakke raises an interesting point. After all, the most important discoveries in science since Boltzmann or even Maxwell have been based on statistical mechanics, mapping likelyhoods and probabilities. And the most virulent skeptics of GCC re-iterate that there is “no definitive proof!” , when GCC arguments have always been closer to actuarial estimates than some kind of Euclidian construct.