In the fourth episode of Allspring’s 2023 outlook series, the topic of conversation is how our climate is increasingly influencing societies and markets and the potential implications of that. Tom Lyons, head of Climate Investment Research, and Nashat Moin, senior ESG (environmental, social, and governance) analyst on the Global Fixed Income Research team discuss this with Jamie Newton, head of Global Fixed Income Research for Allspring.
Tom Lyons: Changes are happening already. They’re happening now. They’re not some distant theoretical possibility.
Nashat Moin: Engagements deepen our understanding of company’s operations and priorities. And they also provide a platform to influence companies on material issues.
Tom Lyons: And we’re taking every action that we can practically here at Allspring to do that right.
Jamie Newton: That was Tom Lyons, head of Climate Investment Research, and Nashat Moin, senior environmental, social, and governance, or ESG, analyst on Allspring’s Global Fixed Income Research team. I’m Jamie Newton, head of Global Fixed Income Research for Allspring, and you’re listening to On the Trading Desk®. As we enter 2023, our climate is increasingly influencing societies and markets. We did some analysis including potential implications. Tom, could you provide us some thoughts?
Tom: Yes, there certainly are. We’re looking at what is truly a global phenomenon. Markets understandably reacted sharply. And this, in turn, caused volumes to plummet in some regions.
Jamie: Nashat?
Nashat: As the climate is changing, it’s important to note that there is an increase in volatility of extreme weather events. We’re experiencing more extreme weather across the globe. For a current snapshot, western U.S. experienced some of the highest levels of precipitation in years. Europe and Eastern U.S. is currently experiencing milder winter temperatures. This has significant consequences on snowpack and related freshwater supplies for later this year.
Jamie: Tom, if some of the weather patterns that we’ve seen persist or even get worse, what types of effects might we see?
Tom: Good question, Jamie. And before jumping in and answering, I should point out that it’s not lost on us that we’re talking about drought at a time when California and the western U.S. is experiencing one of its wettest periods in recent history. Unfortunately, that doesn’t change the big picture of higher temperatures and more extensive droughts that we’re now describing. Many of the reservoirs are only at partial capacity, even after all the rain we’ve seen in December and January. And further, the trends we’re talking about are long-term in nature. Despite short term volatility and rainfall, what we’re talking about here are long-term trends that lead to hotter temperatures and drier conditions. So, we’re very grateful for the rain we’re getting, but we also realize the long-term trend towards more hot, more dry is still in place. Should these trends continue, as most scientists expect, there is a sequence of events that we would expect to happen that would lead to more volatility in commodity and food prices, as well as more frequent inflation in those prices overall. So, first things first, warmer temperatures increase volatility and weather conditions, not just drought. Climate change over time creates both more intense flooding, as well as more intense drought. And that weather volatility is what leads to volatility in crop volumes and prices. Now, precipitation volatility itself also affects crops in a couple of ways. Most important for markets, it suppresses crop growth. So, the transportation logistics disruption is one thing, but what we really want to focus on if we want to gauge the economic importance of weather volatility is how it affects the growth of crops. And we’ve seen quite a suppression of growth in recent years, for example, in the Mississippi River Basin. We add to that the observation that climate change’s physical effects are likely to become more severe over time, especially if we really don’t take drastic action via decarbonization. We think that the distribution of weather events, and therefore, agricultural output will become more dispersed and more asymmetric. Grain supply deficits are going to be more likely than surpluses, according to our analysis. Grain and fertilizer, commodity, and transportation price inflation should rise during those deficits. And this, in turn, simply makes input costs higher for companies that produce food. It’s important to point out, though, when we consider all these dynamics that we can’t look at weather in isolation. For example, as the population grows, we expect it to surpass 10 billion people by mid-century, demand for food will rise. This could add to any supply shortages or imbalances that might occur for other reasons, like weather. Second, increasing wealth in emerging markets, if history is any indication, is going to make people who live in those markets want to adopt diets much more like the developed world. There again, more demand both for grains, as well as for meats, which depend on grains to nourish them. Thirdly, if we look at cropland and what’s happening to it over time, of course, over time, it’s going down as the economy expands. The more demand there is for food, the more demand there is for cropland. And that dynamic is being made worse by drought in places like California. The lack of water that we’re seeing here in California is likely to cause around half a million acres to be left fallow over the next five years. There simply isn’t enough water to support crops profitably in that acreage. We could also add considerations like geopolitical tensions, including the recent and current one in Ukraine. We could add government-imposed export restrictions and the list goes on and on. But when we net out the effects, bottom line is more volatility and more potential for inflation.
Jamie: Nashat, with that as a backdrop, how was Allspring responding?
Nashat: Allspring has a multi-pronged approach. First, there’s the top-down perspective. Bolstering our ESG efforts we have specific working groups on water and climate change. These groups run cross industry analyses to assess risks, as well as opportunities related to climate risk mitigation and adaptation. Additionally, from our bottom-up perspective, our industry analysts are applying robust analytical frameworks to better incorporate sustainability factors, including those related to climate change and to their analysis of individual companies and each industry. And beyond investment research, Allspring engages through our stewardship and engagement team with companies on specific issues. This is essential to our active management as a way to maximize long-term value of our client’s capital while influencing corporate behavior around decarbonization, water energy management, and other sustainability initiatives. These engagements deepen our understanding of company’s operations and priorities. And they also provide a platform to influence companies on material issues.
Jamie: Tom, anything to add or any final words you’d like to put forth?
Tom: The one thing that occurs to me throughout our conversation today is that it’s common for people to think of climate change as this very distant perspective that’s unlikely to really shake up the economy or change people’s lives for several more generations into the future. I think what we’re seeing in the world around us today and based on what we’ve just discussed, is that we at least have to have an open mind when it comes to the prospect that these changes are happening already. They’re happening now. They’re not some distant theoretical possibility. Can we say that the violent weather that we’ve been seeing is necessarily a result of climate change? No, we can’t say that conclusively. However, there’s clearly a scientific consensus that change is underway. Further, whether or not the weather volatility we’re seeing is a direct result of climate change is almost beside the point. It’s impacting people’s lives. It’s impacting the way they eat. It’s impacting the way they support themselves at work. So, if there’s one thing that I would really want to stress from today’s conversation is we need to be doing something about this. And our team at Allspring is committed to rigorously analyzing all aspects of sustainable investment risks, managing them on behalf of our clients, and also pursuing purposeful investment opportunities that can benefit them financially. So, all said, the time to act is now and we’re taking every action that we can practically here at Allspring to do that right.
Jamie: Well, it’s definitely a thought-provoking topic and one with investment implications. Tom, Nashat, thank you both for joining me today.
Tom: Our pleasure. Thanks, Jamie.
Nashat: You’re welcome.
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Disclosure:
Stock values fluctuate in response to the activities of individual companies and general market and economic conditions. Bond values fluctuate in response to the financial condition of individual issuers, general market and economic conditions, and changes in interest rates. Changes in market conditions and government policies may lead to periods of heightened volatility in the bond market and reduced liquidity for certain bonds held by the fund. In general, when interest rates rise, bond values fall and investors may lose principal value. Interest rate changes and their impact on the fund and its share price can be sudden and unpredictable. Investing in environmental, social, and governance (ESG) carries the risk that under certain market conditions, the investments may underperform products that invest in a broader array of investments. In addition, some ESG investments may be dependent on government tax incentives and subsidies and on political support for certain environmental technologies and companies. The ESG sector also may have challenges, such as a limited number of issuers and liquidity in the market, including a robust secondary market. Investing primarily in responsible investments carries the risk that under certain market conditions, an investment may underperform funds that do not use a responsible investment strategy.
