The IPCC Report: Four Takeaways for Investors
Above: Changing by Alisa Singer, 2021 — www.environmentalgraphiti.org
Are your asset managers doing enough?
The latest report on climate change was released in August 2021 by the UN Intergovernmental Panel on Climate Change (IPCC). It is the Sixth Assessment Report (AR6) issued by the IPCC. The first was completed in 1990, recognizing climate change as a challenge with global consequences and requiring international cooperation.
More than 30 years later, climate change is no longer simply a challenge, but an urgent crisis, according to the AR6. The Report is unequivocal in its assessment that human activity during the industrial era has caused global warming, that warming will continue to rise ultimately until global temperatures exceed the 1.5 degrees Celsius increase over pre-industrial temperatures that we have been trying to avoid, but that there is still time for concerted action that could bring down those increases to a more-manageable level by the end of the 21st Century.
Four Takeaways for Investors
Here are several ways for investors and asset managers to address climate change:
Reduce Climate Risk in Portfolios: Make sure the funds/strategies in which you invest are actively considering climate risk and how to reduce it. For asset managers there is really no excuse for not doing this, but judging from the scant information on the topic coming from asset managers, not all of them are doing so. Perhaps not even very many.
Reducing climate risk in portfolios can be accomplished by carefully and systematically assessing the climate risk of every investment, building climate-risk assessments into valuation models, and taking steps to minimize exposure to companies and industries that face significant climate risks.
Keep in mind that climate risk is not limited to fossil-fuel firms and utilities that burn coal and natural gas to generate electricity. It includes firms creating products and services that generate carbon emissions in their usage (think transportation or cloud computing) and those that are heavy emitters in their production processes (concrete and steel, for example). Firms in just about every sector face transition risks as they shift away from reliance on fossil fuels.
(To assess transition risks in funds, a good place to start is Morningstar’s fund-level measure of carbon risk, which assesses how much transition risk the holdings in a portfolio harbor. Here’s a link to a paper I wrote explaining our measure.)
In addition to the risks associated with the imperative to reduce emissions, many firms and their suppliers are physically located in places that are exposed to extreme weather events and sea-level rise, and others may have customer bases residing in climate-sensitive areas, which broadly affects the real estate, banking and insurance industries. Many firms will face growing physical risks as the effects of global warming worsen.
If you are an advisor, ask the asset managers of funds/strategies you use in client portfolios to tell you specifically how they are accounting for climate risk. At this point, every asset manager should have a clearly articulated approach to mitigating climate risk across the full range of strategies offered. It should be front-and-center — easy to find — on their websites.
Unfortunately and to put it mildly, many asset managers are still getting up to speed on how to assess climate risk in their strategies. Until very recently, the only asset managers talking about climate change being relevant to their investments were the relatively few early adopters of ESG.
Pressure Companies to Make Net-Zero Emissions Commitments: Your asset managers should be exercising their influence as major shareholders of public companies to actively demand net-zero emission commitments and follow-through from the firms in which they own shares. Firm-level commitments and data showing progress on them is necessary for asset managers to be able to assess a firm’s climate risk more accurately in the first place.
Again here, if you are an advisor, you should expect your asset managers to be meeting this very reasonable expectation and they should be able to demonstrate that they have been doing this via their engagement and proxy voting activities.
Invest in the Energy Transition: When it comes to investing, climate change isn’t only about risks. Adding exposure to companies that do have climate-resilient business models, and to industries that are creating climate solutions helps finance the transition to a low-carbon economy and seems likely to be a profitable long-term investment theme. This can be done through investing in the growing number of sustainability themed funds now available.
Pressure Policymakers to Address the Climate Crisis: Because climate change poses major systemic and financial risks that will have an economic, if not direct physical impact, on their end-investor clients and on their own profitability, asset managers around the world should be pressuring policymakers to act, and they should be pressuring the companies in which they own shares to pressure policymakers to act.
For advisors, this may seem somewhat far afield from typical investment considerations. But asset managers, especially the largest ones, have enormous resources and considerable clout with policymakers, if only they would use it. So ask them about this one, too.
If you’re an advisor, you should already be acting on all four of these points. If you’re not, you may not be serving your clients well amidst the growing climate crisis.
Article by Jon Hale, The ESG Advisor. Mr. Hale is Global Head of Sustainable Investing Research at Morningstar. Views expressed here may not reflect those of Morningstar Research Services LLC. or its affiliates.
Read additional articles from Jon in his column on Medium, The ESG Advisor and follow him on Twitter: @Jon_F_Hale