Just how great are today’s great investors? We might not know, not yet, because they’ve become great in a great time for investing.
Pimco co-founder Bill Gross recently published a reflective essay on the role of decades-long economic trends in the success of super-investors. In his career, he wrote, he might not have seen enough true variability to know if the epoch made him or if he made the epoch.
He then posed an important question to illustrate his point: What if an epoch changes?
“What if there is a future that demands that an investor -- a seemingly great investor -- change course or at least learn new tricks? Ah, now, that would be a test of greatness: the ability to adapt to a new epoch,” Gross wrote.
The interesting thing about Gross’s choice of words is that in the time he has been an investor, there has been a change of epoch -- a geological epoch -- that might itself prove to be the ultimate test for elite investors.
The Holocene Epoch began about 12,000 years ago, when ice sheets receded, sea levels rose and climate stability reigned. The new geological epoch, which has begun to resonate publicly in the last few years, was dubbed the Anthropocene, or age of humanity, by Nobel laureate in chemistry Paul Crutzen in 2000, and is defined by our dominance over air, land and sea.
To marry the professional jargons of financiers and geologists: Are late-Holocene returns on investment sustainable into the Anthropocene?
Some institutional investors, particularly pension funds, and others with long-term time horizons are already taking a hard look at their portfolios. They’re scanning for new kinds of risk that might interfere with desirable growth, from fossil fuel dependence to overpopulation.
The Known Unknown
There’s a lot we don’t know. How fast we are cooking the planet, for example, is a central question that could significantly influence how we choose to invest and how economic growth proceeds.
After decades of increases, average global temperatures reached new highs in the last 15 years and stayed there. Every year of this century has been one of the top 14 hottest years since 1880. The first decade of the century was the hottest on record, but temperatures didn't rise as steadily as some simulations projected. News media have noticed this discrepancy and published fresh looks at what’s known as climate sensitivity, or the amount of warming we can expect from a doubling of atmospheric carbon dioxide from pre-industrial levels.
New research suggests it could be lower than the estimate of 3 degrees centigrade that has been arrived at frequently since 1979. If that's true, slower warming could give us more time to better manage, or quit, fossil fuels and invent atmospheric carbon-scrubbing machines before the climate passes 2 degrees, the danger threshold adopted by policymakers. The world has warmed about 0.8 degree centigrade since 1900.
Most likely, the last decade is a temporary plateau before surface temperature starts to play catch-up with carbon dioxide emissions. In the long run, uncertainty about the climate-sensitivity estimates is a kind of Thanksgiving turkey. Whether you cook it at 350 degrees Fahrenheit for four hours or 375 degrees for three and a half hours, you're still cooking it.
To Bill Gross, the question is: “What if the effects of global climate change or perhaps aging demographics substantially alter the rather fertile Petri dish of capitalist expansion and endorsement?”
The Unknown Unknown
Nobody knows the answer. So researchers test the implications of varying assumptions in silicon Petri dishes -- computer models.
Modeling climate economics is tricky, even more so than climate science is, if that's possible. The former simplifies the latter and then combines it with additional hard-to-know variables, like consumption, population and energy use. All of these estimates end up in what climate wonks call the “social cost of carbon,” or the estimated cost of future damages, in today’s dollars, per ton of carbon dioxide. Policy analysts use this estimate when scoring proposed regulations that affect greenhouse gas emissions one way or another. Not including it would imply that damages from carbon dioxide emissions aren't expected at all; that's desirable, but it isn't true.
The climate economics debate, as it occurs in journals, news media and the blogosphere, turns on the assumptions that economists pick when they translate future growth and climate damages into today’s dollars. Often at issue is time discounting. The more activist economists say that a high discount rate carries implicit moral judgments, in that it discriminates against future generations -- which have the same legal and moral value as we do -- by sticking them with the costs of dealing with climate change.
Researchers’ different approaches to discounting produce starkly different policy recommendations. There are two main camps. The difference between them comes down to how you feel about applying the Security and Exchange Commission’s standard disclosure -- “past performance does not guarantee future results” -- to the economy at large, and on into the deep future.
One camp, which includes the federal government, makes projections based on how the value of money has changed historically -- looking, for example, at the history of U.S. interest rates. The Obama administration took this approach in 2010 when it arrived at $21 a ton as its average estimate.
This thinking drives the second camp, which includes climate hawks, completely bonkers. They believe that for the global economy, as for publicly traded companies, past performance does not guarantee future results. Rates of economic growth lower than historic trends can’t be ruled out, they say, and it wouldn’t be fair to future generations to project the economy's past performance onto an uncertain future. The U.K. government factored in some of these considerations. Hence, its average social cost of carbon was $83 per ton of carbon dioxide.
Studies by economists in this camp produce estimates that dwarf even that. Estimating a high climate sensitivity, high damages and a low discount rate (meaning that future generations should be “priced” nearly the same as ours), economists Frank Ackerman and Elizabeth Stanton came up with an estimate of almost $900 a ton.
“If we don't manage climate change properly, we don't know that there'll be growth,” said Lord Nicholas Stern, chairman of the Grantham Research Institute at the London School of Economics and the author of a major British assessment of climate change and economics in 2006. “There's a likelihood that it'll be so destructive that there’ll be the opposite of growth.”
The Next Great Investors
The point of all of this work projecting economic growth in a warming world is to guide policymakers toward informed decisions. It is an exercise with limitations. One camp is working from empirical, historical data that can’t necessarily be extrapolated forward with absolute confidence. The other is propelled by moral questions of intergenerational equity; dollars lose value over time and people don’t.
Climate science and economics leave the next generation of long-term investors with wild risks to consider, the worst implications of which today’s cohort might not live long enough to see.
“The problem with the Buffetts, the Fusses, the Granthams, the Marks, the Dalios, the Gabellis, the Coopermans, and the Grosses of the world is that they’ll likely never find out,” if they can hack it, Gross wrote. “Epochs can and likely will outlast them. But then one never knows what time has in store for each of us, or what any of us will do in the spans of time.”
Analysis and commentary on The Grid are the views of the author and don't necessarily reflect the views of Bloomberg News.
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