Similarly, regulatory certainty, exemplified by the Inflation Reduction Act of 2022 in the US, can mitigate cost of capital by solidifying future operating contexts for businesses positioned to thrive within such frameworks.
While it is very unlikely that Cop could achieve anything on that scale, any strides toward policy clarity could influence the discount rates for future cash flows, enhancing business valuations.
The challenge for investors when incorporating these fundamental changes is that we are naturally myopic in our investment outlook; we tend to focus on the immediate impact of any change and typically underestimate the long-term consequences.
The strength of this reaction can precipitate misalignments between asset prices and their intrinsic value, especially when outcomes defy expectations.
Consequently, the third way that Cop can impact asset values is via the sentiment of investors.
For example, a failure to address the lack of promised capital flowing into emerging economies to support carbon transition may lead to more negative sentiment towards investing in emerging economies at a time when investor appetite for emerging market assets is already weak.
However, such disconnections between price and value also provide opportunities for longer-term investors to achieve above-average returns by looking beyond the prevailing sentiment to the fundamental change that lies behind it and investing in assets that are currently unloved.
These three mechanisms for price change can serve as a checklist for investors when assessing the news that emerges from Cop28. Unless policy shifts substantively affect an asset's cash flow or significantly recalibrate investor sentiment, their relevance to the investor may be minimal.
Having established the pertinency of possible changes, the next step is to assign probabilities to the impact of those changes. It is likely that our estimate of these probabilities will evolve over time as more detail is revealed, but by using this approach we are equipped to forestall surprises and make sound decision-making.
As Cop28 unfolds, while we might harbour hopes for transformative strides in the climate arena, as investors, our mandate is to appraise the world through the unvarnished lens of the current reality, not through the rose-colored glasses of what we might wish it to be.
Dan Kemp is chief research and investment officer at Morningstar Investment Management Europe
