• Institute for Sustainable Investing

The Investor's Guide To Climate Change

Divestment isn't the only option.

It’s an approach that leaders from the Beltway to Wall Street have been offering more and more loudly in recent years. Dominic Barton of McKinsey & Co. advocated in a 2011 op-ed1 that the investment community “fight the tyranny of short-termism.” More recently, Morgan Stanley CEO James Gorman urged investors to incorporate companies that prioritize long-term sustainability into their portfolios.2

Much of the attention on short-termism has a role in today’s increasingly volatile markets, particularly in the wake of the Great Recession. With a greater long-term focus, a growing body of evidence suggests, companies’ financial performance becomes more predictable—and often, as it happens, more profitable3. But a related thread runs parallel to that discussion: the appreciation of massive economic threats posed by climate change, the ultimate long-term risk.

“Far from being just an exercise in risk mitigation,” Gorman wrote4 in a publication appropriately titled Focusing Capital on the Long Term, “[sustainability] represents a significant growth opportunity for those companies that successfully anticipate the products, strategies, and services that the future will demand.”

A Global Investor Survey5 found that 81 percent of asset owners and 68 percent of asset managers viewed climate change as “a material risk or opportunity across their entire investment portfolio,” while The Economist Intelligence Unit estimates—conservatively—that private investors are at risk of losing $4.2 trillion between now and the turn of the next century because of a warming planet.

In the face of escalating effects from climate change, 2016 looks to be a tipping point in action given international negotiations among more than 190 nations concerning carbon emission regulations 7. But what makes this year’s discussions different from climate conferences in the past is the vocal support from the investment community of sustainable business practices and government policies worldwide.

INTERACTIVE INSIGHTS

WHAT TO DO ABOUT CLIMATE CHANGE

Click to Explore the Options

  • ADAPTATION

  • MITIGATION

Structural/Physical

  • Engineered and Built Environment
  • Technology
  • Ecosystem
  • Social Services

Coastal protection & Flood Levees: “Due to sea level rise projected throughout the 21st century and beyond, coastal systems and low-lying areas will increasingly experience adverse impacts such as submergence, coastal flooding, and coastal erosion.”

Coastal protection & Flood Levees: “Due to sea level rise projected throughout the 21st century and beyond, coastal systems and low-lying areas will increasingly experience adverse impacts such as submergence, coastal flooding, and coastal erosion.”

New crop varieties, genetic techniques, efficient irrigation: “For the major crops (wheat, rice, and maize) in tropical and temperate regions, climate change without adaptation is projected to negatively impact production for local temperature increases of 2°C or more above late-20th-century levels, although individual locations may benefit.”

Afforestation and reforestation can create natural storage for CO2 to further loss to the atmosphere. Meanwhile, green infrastructure can limit CO2 emissions.

Social safety nets and food banks: Climate-related hazards affect poor people’s lives directly through impacts on livelihoods or destruction of homes and indirectly through, for example, increased food prices and food insecurity.

Reduction in GHG Emissions

  • Energy Supply
  • Energy Demand
  • Carbon Pricing
  • Energy Storage

Alternative Energy Sources: Renewable wind and solar power provide the fastest growth low-carbon alternatives to powering our energy-intensive society.

Supply-Side Fuel Switch: Gas is on track to replace coal as the top electricity generation source by 2030. Strong growth is expected for wind and solar even though policy uncertainty has delayed renewable deployments.

Energy Efficiency & Conservation: In addition to lower-carbon sources of energy, we need to deliver more services for the same energy input or the same services with less energy. In order to achieve the 2 degrees scenario: (1) Energy use in industrial sectors needs to be cut by 13% by 2025 (2) Growth of final energy consumption in buildings (currently ~1.5%) should not exceed 0.7% per year through 2025.

Alternative Fuel Vehicles: Sector growth is below expectation as major auto makers are pulling back investment in electric vehicles; however, battery cost is expected to drop significantly, and progress is expected around range/charging issues.

Carbon Pricing: Carbon pricing serves as a market mechanism to reduce CO2 emissions and can take two forms: (1) Carbon Tax (2) Permits/Allowances

Energy Storage: Renewables are intermittent and unstable, posing significant challenge for grid integration. Energy storage can help smooth out energy supply thus increasing the commerciality of renewable energy.

Capacity Increase of Carbon Sinks

  • Carbon Capture and Storage (CCS)

Carbon Capture and Storage (CCS): CCS captures CO2 pre- or post-combustion and then transports it through pipelines to geological reserves to be stored deep underground. There is the potential to deliver 13% of total emission reductions through technology by 2050, though it is still prohibitively costly.

According to the Intergovernmental Panel on Climate Change, the net damage costs of climate change will only increase over time8Sea level rise, heat waves, flooding and wildfires will keep impacting the U.S.—not to mention the rest of the world—as gigatonnes of carbon continue to pour into earth’s atmosphere.9

“As someone who has spent a good deal of time assessing risk and dealing with crises, I’m struck by the similarities between the climate crisis and the financial crisis of 2008,” wrote Henry Paulson, founder and chairman of the Paulson Institute at the University of Chicago, former U.S. treasury secretary, and former chairman and CEO of Goldman Sachs, in an April 2015 commentary10. “The greenhouse-gas crisis, however, won’t suddenly manifest itself with a burst, like that of a financial bubble. Climate change is more subtle and cruel. It’s cumulative.”

Paulson joined with former New York City Mayor Michael Bloomberg and philanthropist Tom Steyer to measure the financial cost of climate change for three specific sectors11 of the U.S. economy: agriculture, energy, and real estate. The results—using current emissions as a benchmark—“were sobering,” he wrote.12

The projections showed the financial toll of storms along the East Coast and Gulf of Mexico increasing by 11 to 27 percent in the next decade and a half, “representing an additional $3 billion to $7 billion in average annual damage.” Similar damage is expected across the U.S., from declining crop yields in the Midwest to limited outdoor working hours in the South.13

Worldwide, the toll is staggering. A recent report out of Stanford University and UC Berkeley found that the warming effects of climate change could cause a 23-percent drop in global income by the end of the century14, without intervention or adapting the way our societies operate—from business strategies to political action.

To keep global warming from exceeding the critical threshold of 2° Celsius that all but guarantees those consequences15, the United Nations has brought together more than 40,000 participants in Paris this month for one of the largest climate conferences ever organized, including global, political and business leaders 16.

The conference aims to create a universal, legally binding agreement on climate change, with 26 countries and territories having already submitted target goals for curbing greenhouse gas emissions—almost all by 2030.17

At the same time, an alliance of corporations known as the We Mean Business Coalition is advocating businesses to adopt sustainable practices in kind. From Ikea to Sony to Coca-Cola, the coalition has organized more than 400 businesses to commit to sustainability on top of whatever regulations are enacted by governments worldwide18. Between adopting science-based emission reductions targets and increasing reliance on wind, solar, and other renewable energy sources, they’re aiming to be a driving force toward a carbon-neutral future.

Far from being a purely altruistic cause, these businesses have joined the fight against global warming because recent studies have revealed that sustainability aligns the world’s long-term future with their own self-interest. After Morgan Stanley’s Institute for Sustainable Investing analyzed the performance of over 10,000 open-end mutual funds and 2,000 Separately Managed Accounts (SMAs) over seven years, the firm “ultimately found that investing in sustainability has usually met, and often exceeded, the performance of comparable traditional investments. This is on both an absolute and a risk-adjusted basis, across asset classes and over time.”19

These sorts of results make it no surprise that five out of the top 10 companies in the S&P 100 index identified climate change as a risk factor in their 2014 10ks, according to a Morgan Stanley Equity Research report, “Addressing Climate Change and the Investment Implications.”20

So what can investors do to align their portfolios with sustainable businesses?

The simplest way—pioneered by American universities in the apartheid era—would be divestment: avoid investing in the least sustainable companies that are contributing to climate change and the economic damage that comes with it. More than 400 institutions across 43 countries representing $2.6 trillion in assets have already committed to this divestment strategy.21

Yet avoiding obviously unsustainable companies is just part of the assessment investors ought to consider, and may not be the most strategic approach an investor can take. The harder and more opportunity-laden questions they have to answer are where to invest instead and how exposed their investments are to climate risks.

According to Bloomberg Business, investors with nearly $800 billion in assets have agreed to shift money into more climate-friendly investments such as wind and solar energy23. With more and more investors focusing on ESG (Environmental, Social and Governance) goals, green bonds are also becoming an attractive option for those looking to move money away from fossil fuels and yet still potentially reap similar returns from the market.

According to international law firm Morrison Foerster, green bonds are “thought of as a debt security,” the proceeds of which “have been earmarked for use in special projects that advance environmentally-friendly objectives” such as renewable energy and climate-friendly projects24. In 2013, nearly $11 billion worth of green bonds were issued. Just a year later, according to HSBC, that number tripled to over $36 billion.25

Whether through green bonds or other products, investors have a number of new options for moving their portfolios away from what they deem to be high-risk industries from an ESG goals perspective and toward sustainable and forward-thinking industries at home and abroad.

These sustainable investment approaches are only going to grow in number and size in the coming years, according to Chris Geczy, adjunct finance professor and academic director of the Wharton Wealth Management Initiative26. What that suggests is that investors worldwide are beginning to buy into the emerging research—that you don’t sacrifice return potential by integrating ESG. Put another way, the research shows that you can do good for the planet’s future while also doing well for yourself.

“It’s not a question of whether to adopt” a sustainable investment strategy, Geczy said, “but how to adopt and how much27.”

And those who act decisively and early, with a deliberate analysis of their investments’ exposure to climate risk, are likely to see the greatest benefit from changes in patterns of investment in sectors most exposed to climate change.

Harvard Business Review: Capitalism for the Long Term

Morgan Stanley: The Long Term Imperative for Financial Institutions

Morgan Stanley: Sustainable Reality: Understanding the Performance of Sustainable Investment Strategies

Morgan Stanley: The Long Term Imperative for Financial Institutions

52013 Global Investor Survey on Climate Change

The Guardian: Everything you need to know about the Paris climate summit and UN talks

NASA: Global Climate Change: Vital Signs of the Planet

The Guardian: IPCC: 30 years to climate calamity if we carry on blowing the carbon budget

10 McKinsey & Company: Short-termism and the threat from climate change

11 Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies.

12 McKinsey & Company: Short-termism and the threat from climate change

13 McKinsey & Company: Short-termism and the threat from climate change

14 Stanford: Stanford researchers’ calculations reveal higher-than-expected global economic cost of climate change

15 CNN: Climate: 7 questions on 2 degrees

16 Community Environmental Council: COP21/CMP21: The UN Conference on Climate Change

17 Morgan Stanley Equity Research, “Addressing Climate Change and the Investment Implications,” August 2015

18 We Mean Business Coalition

19 Morgan Stanley: Sustainable Reality: Understanding the Performance of Sustainable Investment Strategies

21 Morgan Stanley Equity Research, “Addressing Climate Change and the Investment Implications,” August 2015

22 DivestInvest: Measuring the Growth of the Global Fossil Fuel Divestment and Clean Energy Investment Movement

23 Bloomberg: Fossil-Fuel Divestment Movement Exceeds $2.6 Trillion

24 Morrison Foerster: Impact Investing and Green Bonds

25 HSBC: Bonds and Climate Change: The State of the Market in 2015

26 Phone interview with Geczy

27 Phone interview with Geczy

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