As the lines between structural, macroeconomic, societal and technological changes blur and collide, institutional investors can identify emerging investment opportunities with new tools and data, according to dialogue and discourse among asset owners and researchers at the MSCI Canadian Institutional Investor Forum.
The Nov. 15 event, held at CPP Investments Headquarters in Toronto, was the 10th forum hosted by MSCI for the Canadian institutional investor community. Echoing the sentiments of global asset owners and investment consultants who attended a sister forum in Sacramento, California last month, the Canadian forum attendees debated how an onslaught of new geopolitical and macro risks, increased demand to invest in illiquid private markets and climate change have made the asset allocation process more challenging.
Investors who successfully manage these new risks may also find new rewards, in the form of companies that are better positioned to generate portfolio returns as global economic and market dynamics change, Henry Fernandez, MSCI Chairman and CEO, said at the event.
“The ability for all of you to understand risk and to price risk, and to understand opportunities and assess those opportunities, is paramount as the world order shifts,” he explained to investors at the forum. “These are times of difficulty, of uncertainty and of shifting to a new paradigm — and they create enormous opportunities. If you look at financial history, some of the biggest investment opportunities came in difficult times when prices were out of sync, correlations were off-kilter and risk wasn't being priced properly. Those investors who have that vision, as well as the necessary tools and data to understand how assets evolve during and after periods of turmoil, will remember this period for the opportunities they found.”
Just days away from the kickoff of COP28 in Dubai, Fernandez noted that the effects of climate change on world economies necessitate the development of new tools to enable investors to better manage risk, price assets and uncover opportunities concurrently. For example, capturing and analyzing corporate disclosure of emissions, the geographic locations of their data, facilities, water use and scores of other actions is a risk-management challenge that requires new models and technologies. By extracting, tracking and measuring such information, Fernandez said, investors can gain a clearer picture of the “climate winners and losers” in their portfolios.
“The financial investment industry needs to achieve a continued awareness and realization that climate risk is a huge risk, and investors are increasingly seeking to accelerate the de-risking of those portfolios,” he said. “The issue becomes, what's the pace of investing in the current fossil fuel energy infrastructure of the world versus the pace of investing in the future renewable energy infrastructure of the world? That's the balancing act, striking the right path of decarbonization and de-risking in order to achieve maximum returns and lower risk in your portfolios.”
Chris Cote, vice president for sector and thematic research at MSCI ESG Research, said investors are increasingly considering ways to turn the risks associated with the shift to a net-zero economy into opportunities, thanks in part to policies that have lowered the cost of transition technologies. He cited the Inflation Reduction Act and infrastructure law in the U.S. as an example of a policy that aims to lower the total cost of investment in wind and solar, batteries, electric vehicles, carbon capture and storage, low-emissions manufacturing and other technologies at the core of the climate transition.
But a law like the Inflation Reduction Act is “merely a down payment” in transitioning towards a less carbon-intensive global economy, Ashley Lester, global head of research at MSCI, remarked.
A low-carbon transition sufficient to meet global primary energy needs would require at least USD 2.2 trillion in annual average investment in low-carbon technologies and infrastructure each year between now and 2050, MSCI ESG Research analysis of the “Net Zero 2050” scenario developed by the Network for Greening the Financial System (NGFS) found. This would amount to more than USD 60 trillion between now and 2050.
“People have this figure in mind of tripling investment in this area,” Cote explained when sharing these findings at the forum. “Most of the spending that needs to be done is in areas that we know a lot about and has been happening already. There aren't secret ingredients to renewables and clean electricity. Investing in them profitably, investing in them in a timely manner, investing in them in a way that is just and accepted by society — that's still very hard and needs to be unlocked. But the technology is there, and the cost-competitiveness with alternatives is largely there.”
MSCI ESG Research also shows that in the most emissions-intensive sectors, for example, companies that had a higher share of revenue from alternative energy, energy efficiency and green buildings had significantly faster earnings growth than their sector peers over the last several years.
Canadian asset owners have introduced new frameworks to identify opportunity and risk in the climate transition, which were discussed at the forum. Conviction behind sustainable investing in Canada has grown stronger, according to new data from the 2023 Canadian Responsible Investment Trends Report, released by Canada's Responsible Investment Association (RIA) last month.
Researchers at the MSCI Climate Risk Center are also creating forward-looking models to help investors seeking to project costs and possible opportunities associated with climate change, Lester noted. “We break the world up into approximately 25x25 foot plots, map onto them information about millions of properties and then project, under a variety of climate scenarios, the number of extreme heat days, fires, floods and so on that will affect each square of land on the planet,” he noted. “This is incredibly detailed and skillful work. Will it be wrong? Of course — in the way that all models are wrong. But is it the best guide we can have to figuring out the likely physical risks and costs of climate change? Of course.”
Lester and Raman Subramanian, managing director and global head of MSCI’s solutions research team, both led discussions at the forum that touched on how forward-looking risk management tools like scenario analysis are further expanding institutional investors’ ability to generate alpha — in other words, outperform the market.
“As global markets become increasingly complex and interconnected, traditional investment strategies may no longer be sufficient,” Subramanian said. “In order to navigate these challenges, asset managers are incorporating new signals and data sets into their investment strategies. They are also employing a disciplined portfolio construction approach, seeking to optimize returns while managing risks.”
Subramanian said a notable shift is also taking place among fundamental asset managers, who traditionally leaned on qualitative analysis and intuition to assess investment risks and opportunities. Increasingly, these managers are integrating quantitative and alternative data signals into their decision-making processes.
“Integrating these new sources of information allows them to gain deeper insights and detect trends that are perhaps invisible to traditional approaches,” he explained. “As a result of this evolution, the distinction between fundamental and quantitative strategies has blurred.”
Abhishek Gupta, executive director and leader of the equity solutions research team, noted that a 2023 MSCI survey of asset managers don’t view traditional investment factors as static. Instead, investors surveyed said they believe that factor definitions should evolve through time — and that new factors may be discovered from alternative datasets or using advanced techniques, such as machine learning.