Why Countries Need to Get Out of Their Comfort Zone
A s we head toward one of IMH’s conference rooms, Dominic Schnider wonders aloud why I’m wearing a jacket, while Antonia Sariyska, in jocular mood, remarks that despite it being December, the sea temperature was still warm when she went for a swim off Limassol. It is the first visit to Cyprus for the two of them (they’re here to attend a red-carpet event) and they have travelled from bitterly cold Switzerland, where they work in the Chief Investment Office (CIO) of UBS Global Wealth Management. I explain to them that, in the past couple of years, the climate on this side of the Mediterranean appears to have turned tropical and Christmas celebrations on the island have acquired something of an Australian accent, weather-wise.
Ah yes, climate change. The vision of a net-zero carbon future by 2050, repeated at last year’s COP27 conference, is an admirable one but a growing chorus of experts believes that no international agreement or any other top-down commitment is enough to make it a reality. Sariyska is one of them. Six years ago, following her work with clean-tech startup MAKE Bulgaria, where she led fundraising and business development activities, she joined UBS’s CIO Sustainable and Impact Investing team. The team creates frameworks and provides guidance to the firm’s private clients – UBS is the largest wealth management company in the world – on how they can leverage their purchasing power to nudge companies into making more sustainable decisions, which usually involves more carrot than stick. “It will take a whole village,” she says, in reference to the imperative of a collective effort to create so-called green economies, and adds: “One of the things we like as a part of sustainable investments is bondholder and shareholder engagement with companies. What are their commitments? How are they phasing out carbon? How are they thinking about supply chains and infrastructure deployment?”
To date, more than 3,000 companies worldwide are setting – or are in the process of committing to – emissions reduction targets through the Science Based Targets initiative, a collaboration between the CDP, the United Nations Global Compact, World Resources Institute, and the World Wide Fund for Nature. At the same time, rising consumer interest in electric vehicles, renewables and other green technologies is driving companies to embed sustainability into their business models. However, inflationary uncertainty, an imbalance between supply and demand, and the financial chasm between developed and developing countries that results in different energy needs, create complications.
In Europe, inflation appears to have eased at a feverish 10%, which suggests that the ECB’s record interest rate rises – their only counterweight against dangerously spiking consumer prices – might stop at around 3%. For Schnider, this can only mean that growth will slow down. He leans forward and says, “2023 will feel extremely slow, almost as if we’re standing still but we’ll be temporarily in a recession and then inflation will go away.”
Schnider is a one-company kind of man. He’s been with UBS for over two decades, starting as a financial analyst, mainly reporting on the Asian markets, and has moved up through the ranks to become Global Head of Commodities and Forex. While describing himself – with a touch of self-deprecating humour – as a pessimist, he does not fail to find a small silver lining in the idea of economic growth coming to a screeching halt – indeed, it would be more appropriate to call him a realist. “Finally, after a decade of being deprived financially and forced into risky assets because that’s the only way they could get an additional yield, savers will finally get something. I mean, it’s only fair, isn’t it?” he says. “I think we have too often increased long term risks in order to prop up near-term growth and this has started to bite us through higher inflation this time around,” he adds as an afterthought.
The awakening of the Sleeping Giant, which will most likely come with the Chinese New Year – in Western terms, it translates to the second quarter of 2023 – will reverberate across global markets. Considering the hardcore lockdowns in China over the past two years, it is safe to say that the recovery will be consumer-led. For Schnider, this is good news for OPEX-related commodities and possibly for the Cyprus tourism industry, as Chinese tourists venture to vacation in warmer climates following their stuffy stay-at-home living conditions. With a broad smile, he says that commodities could be on track to complete a hat trick following two consecutive years as the best performing asset class, something that has not happened before in recent memory. “From an investor’s perspective, I would urge everybody to have some exposure to commodities,” he says. “If you don’t want to speculate because you don’t like it, then look at it as insurance.”
Europe’s inflation is tied to the energy crisis following Russia’s invasion of Ukraine, which is a key differentiator in what drives inflation in the US. In a dramatic reversal of history, the new iron curtain that is falling over the Old Continent has found some 2.5 million barrels per day of Russian oil looking for a new home, with European politicians betting that they could outsource that supply to the US. On the other hand, Russia has cut off mainland Europe from its gas pipelines, leaving experts to wonder whether inventories will survive a long, cold winter. “Our message to everybody is that, price uncertainty related to commodities is here to stay, which requires proactive risks management – just hoping prices would not go up is not good strategy,” he says.
“Contrary to popular belief,” Sariyska says, “inflation is good for sustainability.”
“How is that?” Schnider and I ask as one voice.
“I mean that energy efficiency is a pricing mechanism. Even if you don’t care about people and the planet, you will still face these massive price increases. So, you have to start adapting your business model to be more efficient with the resources at hand. Unfortunately, events like the war are accelerating the transition,” she explains.
Going back to inflation hedges, Schnider finds inflation-linked bonds attractive as a short-term solution, and real assets from a long-term viewpoint, which includes commodities – to some degree, this also includes real estate but, as rates go up, that will inevitably hurt investors. “I would focus on companies that still have pricing power, and again these are companies that are either linked to commodities or business models that are independent of cyclical swings,” he says. “The last point to think about inflation hedges concerns currencies. Switzerland, for example, has only 3% inflation and, in the medium-term, that will translate into a stronger Swiss franc.”
“Can any ESG investments act as hedges?” I ask.
Schnider turns to Sariyska. “What do you think?”
“I think you can find a sustainability focus in different asset classes,” she says. “But, if we are thinking about commodities that will help facilitate the transition to a low-carbon economy, llike lithium and copper, then we want to encourage miners to be cautious of handling nature and local communities.”
According to private banking firm S&P Global, an electric vehicle requires 2.5 times the amount of copper than a combustion engine does. Aluminium and iron ore are used in the construction of solar panels, and cobalt, a copper by-product, is a key component in lithium-ion batteries for phones, laptops, and electric vehicles. Most experts, including the two sitting across from me, predict that there won’t be enough supply of these green transition metals to keep up with the rising demand, especially when it is controlled by a few geopolitical players: China leads the race for copper and Congo (DRC) for cobalt. In 2022, according to the World Bank, the prices of these metals rose by between 20% and 91%. “I think you need to ask yourself: In the decades ahead, how do we want to transform the economy and where it’s going to be structurally in balance? Have we made the right investment in, let’s say, copper supply? No, we haven’t,” Schnider says. “Because guess what, nobody wants to have a copper mine or an aluminium smelter in their backyard. So, the supply side will remain quite constrained, and for good reason.”
The realist in him says that the developed world has not only failed to secure the supply chain for these metals but has also fallen short in engaging with emerging economies to speed up the exit from fossil fuels. By 2026, China’s insatiable consumption appetite will peak at about 16 million barrels of oil per day, while India stands to triple its daily guzzling of five million barrels sooner than later. “Where will that oil come from to meet stronger emerging market demand if nobody wants to invest?” he wonders. “I don’t think the developed world holds the moral high ground on this topic.””
The different attitudes toward the green transition become more prominent between developed and emerging economies where any discussions about decarbonisation take a back seat, while food, shelter and security come to the forefront. For these economies, the demand for natural gas, which was voted in 2022 to stay in the EU’s taxonomy of green investments, will grow substantially in the next decade.
“So, is the notion of a low-carbon future a luxury problem? Do you only start getting worried once you’re economically developed?” Sariyska asks. “I think we can safely say yes.”
At last year’s COP27 climate talks, finance took centre stage on how wealthier countries and investors can fund low- and middle-income countries to facilitate their green transition efforts. However, as Sariyska notes, there hasn’t been a formal agreement yet on how to reshuffle finances or on where that money should go. “But we are seeing some promising things: the US and China renewing their cooperation on climate, for one,” she states. “They are trying to say, ‘
We are the two largest polluting economies; we have made it in terms of development but we also have a certain degree of responsibility.’ Hopefully, that comes across as a positive message for the new year.”
Schnider adds, “Maybe saying this is controversial but, with gas prices being so high, there is a positive element in that finally governments will wake up and accelerate what they should have done many years ago. It is so convenient to stick to the ‘same old’ but being pushed out of their comfort zone will lead to change.”
“In the car on the way here,” Sariyska says, “we were talking about the fact that, as humans, we have adapted to a lot to changing environments.”
“Well, that’s quite optimistic,” her colleague says in a bantering tone.
She laughs. “Hopeless optimist here!” she says. “But what is the economic and environmental landscape that we want to leave to our children and grandchildren? We call it an environmental credit crunch; we are borrowing from them now. The planet will still be around, but the question is: Will that be a planet we want to live on?”