Economics & Markets

Rising energy costs are eroding retirees’ financial well-be

By AMP Capital

Regardless of whether you think climate change exists or not, the flux when it comes to energy policies is having unintended consequences beyond high energy prices.

Self-funded retirees are bearing the brunt of this as they are being crunched three ways.

Their cost of living is rising, which means retirees are drawing more cash flow from their superannuation investments to support their spending including paying energy bills. According to the Association of Superannuation Funds of Australia Retirement Standard, this figure is typically about 10 percent of retirees’ total consumption.

Secondly, when we manage retirement income portfolios to fund these essential spending goals, we look for Australian companies with high and sustainable dividends. But because many of these companies face higher energy input costs, their cash flows and dividend paying power are under threat. There is a secondary impact of this on retirees as many of them directly invest in these companies for dividends that supplement their income.

They are also impacted by fund managers’ inability to effectively hedge energy on their behalf because of the frequent government policy changes during the past decade. If we could reallocate 5 percent of the retiree’s portfolio from fixed income and invest it in new sustainable sources of electricity production, there would be an improvement in the stability of inflation-hedging cashflows from both parts of the portfolio as well as improved societal outcomes as a result.

Risk adjusted portfolio returns might improve by 10 – 20 basis points, according to our own analysis, which corresponds to $500 - $1000 per annum for the retiree.

But we can’t make this hedge.

It is too risky investing in energy infrastructure on the behalf of retirees unless the rules of the game are widely agreed and sustainable.

From a risk management perspective, there are too many unknowns and some of these are significant such as a company’s right to operate, new taxes, access to research and development funds, and social pressures.

The federal government’s latest policy – the National Energy Guarantee – may not garner the bipartisan support it needs without significant changes to emissions reductions targets, in part because there remain very wide-ranging opinions about climate change policy within the major parties.

Such divergent policy (not to mention political opinions) means the appetite for companies exposed to power – be they major emitters or green companies – is diminished.

The rules need to be set because the investment required to address the energy crisis has a long-term payback period. The discount rate required to fund that investment depends on the perception of cash flow risk over the long term.

Absent a stable set of rules that is broadly supported in the community and backed by good regulation, the discount rate will be too high to justify the allocation of capital.

In short, it’s a sovereign risk although it’s fair to say our leaders – including business leaders – do recognise this.

In the recent preliminary release of the World Economic Forum Global Risks 2018 report, Australia was the one of only two countries to include adapting to climate change within its top five risks. It was also the only one to put energy pricing as the leading concern for businesses within the next ten years.

There are also ethical aspects to consider when it comes to climate change and energy policy.

Since the Paris Accord of 2015, which saw more than 190 countries agree to limit global warming, super funds and their managers, such as AMP Capital, have needed to consider how their investments in fossil fuels could be impacted by government efforts to reduce climate change.

AMP Capital considers all investments through its Environmental, Social and Governance (ESG) lens. So when it comes to decisions on energy investment, we are acutely aware of the need to consider the social licence to operate, now and well into the future. That influences where we invest, how we engage with investee companies and how we operate directly-owned assets.

We are not alone in asking investee companies to account for the social and environmental consequences of their actions, in addition to their financial results. A growing number of pension funds and sovereign wealth funds across the globe are pulling out of investment in companies that earn money from fossil fuels, citing ethical and financial reasons.

Many of us think there should be a fiduciary duty of directors to maximise shareholder welfare in conjunction with shareholder value. Hence the increased focus on companies’ carbon footprint.

Developing a bipartisan strategy to provide a reasonable trade-off between reliability, affordability and environmental sustainability in the energy sector may be challenging, but it is hopefully something our community leaders can do.

Without a broadly agreed plan, the cost of capital in the energy sector will remain unnecessarily high.

Under such conditions, super funds will not broadly support significant new investment in electricity production. While this will affect the whole community, retirees are the cohort facing the most evident blow to their financial well-being.

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Important notes

While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455)  (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

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