End of Week Notes
The IPCC Report: 4 Takeaways for Investors
Are your asset managers doing enough?
The latest report on climate change was released this week 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.
If you are a non-scientist (or a scientist who doesn’t have time to read the full 1300-page report), consider yourself a “policymaker” and read the 39-page Summary for Policymakers. Or simply download the 2-page “Headline Statement” for policymakers, and take a look at some of these media accounts:
4 Takeaways from the IPCC Report
The Cause is Certain: Human activity is causing the Earth’s climate to change because of the burning of fossil fuels during the industrial era. The amount of carbon dioxide and other greenhouse gases in the atmosphere is increasing global temperatures on a scale that is unprecedented over anywhere from “many centuries” to “many thousands of years”. No more “maybes”. No more “pretty sures”. The world’s scientific consensus is now “unequivocal”.
It’s Happening Now: Climate change is already affecting weather patterns and causing extreme weather events throughout the world. The report provides evidence, but really, so do the newspapers every single day, and for millions of people, so does waking up in the morning and looking outside.
It’s Going to Get Worse: Global temperatures will continue to warm at least until mid-century under all the carbon-reduction scenarios considered in the Report. As a result, global warming of 1.5 degrees Celsius over pre-industrial levels will likely be exceeded by mid-century and that increase could be 2 degrees Celsius or higher unless deep reductions in carbon dioxide (CO2) and other greenhouse gas emissions occur in the coming decades. If deep reductions do occur by mid-century, global temperatures could decline to more manageable levels by the end of the century.
As global warming increases over the coming decades, the cumulative effects of climate change are going to get worse. And while certain catastrophic outcomes are still considered to have a low likelihood of occurrence, the Report warns that some of the most extreme outcomes cannot be ruled out.
It’s Not Too Late to Take Action: Limiting future climate change requires drastic reduction of carbon emissions and major reductions in other greenhouse gas emissions. Reaching net-zero carbon emissions by 2050 could lower temperatures below the 1.5 degree Celsius increase threshold by the end of the century.
4 Takeaways for Investors
Here are four ways for investors 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.
Policymakers, on the whole, now seem more inclined to take decisive action and there are fewer out-and-out climate-change deniers among them. But as Michael E. Mann has argued, there remain many climate “inactivists” who downplay the need for action and seek to delay implementing solutions.
A textbook example from this week:
Your asset managers should already be acting on all four of these points. If they aren’t, you may not be serving your clients well amidst the growing climate crisis.
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It’s been a while since we’ve checked in with him, but I’m happy to see that GMO’s legendary investor Jeremy Grantham, is thinking along these same lines. Here’s a recent dialogue between him and Morningstar CEO Kunal Kapoor:
Also of note:
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