New report highlights the importance of asset owners stress testing investments in the face of rising demand for resources.
Asset owners have been urged to better assess future consumption-related risks in their portfolios as population growth, life expectancy and the climate crisis collectively put pressure on resources.
“The impact of forecast consumption trends may not hit from an investment perspective today or tomorrow, but it’s a risk conversation that investors need to be having now,” Charles Sincock, Managing Director of ESG Advisory and Strategy at consultancy firm Marsh Advisory, told ESG Investor.
Sincock is the lead author of ‘Global resource consumption and its impact on the ESG agenda’, a report published by Marsh this week which explores the interaction of consumption trends with risks relating to climate change, nature degradation and biodiversity loss. The report said that consumption levels will hamper the ability of many investors and companies to realise their ESG goals.
Consumption pressures are already materialising, according to Sincock. He pointed to the global microchip shortage, which was exacerbated by the increased demand for consumer goods during the height of the Covid-19 pandemic.
“Asset owners with long investment horizons need to be reviewing their investments and considering whether their current risk-reward and ESG metrics will hold in the longer term,” he said.
“Are they factoring stress testing and scenario testing of growth in demand for raw resources into these longer-term investment plays?”
Investors should prioritise aligning their return-on-investment (ROI) timescales with the long-term issues related to consumption pressures over shorter term motivations, the report said.
Further, investors need to be assessing whether investee companies have conducted a forward-looking analysis of how physical risks – like an increase in natural catastrophes – may impact their supply chain and current value proposition, as well as how increased consumption may exacerbate those risks, it added.
“More stress testing, more strategy, more thinking needs to happen around the resilience, viability and stability of current business models in line with consumption trends,” said Sincock.
The ability of an investee company to assimilate, adapt and find opportunity “will have a significant impact on their competitive advantage and ultimately long-term shareholder value creation and retention”, the report added.
Sustainability-focused disclosure frameworks such as the Taskforce on Climate-related Financial Disclosures (TCFD) and Taskforce on Nature-related Financial Disclosures (TNFD) are encouraging firms to disclose transition plans, which the report said contributes to the necessary “reshaping [of] both the tactical conduct and strategic thinking of management”.
“Integrating ESG metrics, science-based targets, regulations, and corporate positioning aspirations into a future-state target operating and business model will be fundamental,” the report added.
“The associated risk factors can then be captured, modelled and mitigated in enterprise risk management (ERM) systems for enduring value creation and protection.”
Carrot and stick
As well as viewing growing global consumption from risk management lens, there are opportunities to be capitalised on as the world shifts to a more sustainable economy.
“It’s a carrot and a stick of opportunity,” said Sincock.
“Yes, investors need to be mitigating the downsides, but there is going to be a pipeline of future solutions that need investment.”
Recycling capacity for electric vehicle (EV) batteries was identified as one such opportunity that will support a more circular economy and manage the consumption demand for critical minerals.
The 2023 ‘Circularity Gap Report‘ noted that rising material extraction has shrunk global circularity from 9.1% in 2018 to 7.2% in 2023, with more than 90% of materials currently wasted, lost or unavailable for reuse for a long period of time.
A report by consultancy firm McKinsey noted that investing in a circular economy for cement and concrete could produce over US$116 billion in net value, while mitigating two billion tonnes of CO2 emissions by 2050.
Last year, the UN-convened Principles for Responsible Investment (PRI) also published guidance outlining how investors can support the global transition to a circular economy.
“Consumption will reach a tipping point within the average investor’s lifespan; they will see significant pressure on the fundamentals,” said Sincock.
“Looking over the horizon at consumption trends, and making good choices now, will create more viable, harmonious and stable economies for all in the future.”