Fiduciary Responsibility, Climate Change Bids Investors into Action
Art by Malina Omut
The known and moreover unknown investment challenges presented by climate change are increasingly provoking institutional investors into action. While the approach to managing sustainable risks may differ across portfolios, the impetus for addressing climate concerns remains the same: to act as prudent investors.
“As a fiduciary of Harvard University’s endowment, HMC [Harvard Management Company] believes that it is crucial to consider climate risk and its effects in our investment processes,” Kate Murtagh, HMC’s chief compliance officer and managing director of sustainable investing told CIO Magazine. “ESG factors, such as physical or transition risks associated with climate change, provide valuable signals in a manager’s investment process. The successful integration of ESG factors in our investment process advances our goal of producing strong long-term results.”
Last month, the nearly $41 billion endowment managed by HMC joined the Climate Action 100+, an investor initiative to influence the world’s largest corporate greenhouse gas emitters. “The initiative’s goals not only better position companies to address the risks of climate change, but also seek to protect long-term value for investors—much like our own consideration of ESG factors throughout the life of an investment,” Murtagh added.
Harvard is not alone.
Another high-profile signatory to the Climate Action 100+, the GBP 8.2 billion Church of England, beefed up its corporate engagement team in September with the announcement of two hires to ramp up the fund’s work in influencing companies related to the sustainability and ethical matters.
“The increase in engagement resources is part of our commitment to run industry-leading engagement programs that demonstrably change corporate performance on ESG issues – including on our highest priority issue, climate change,” said the fund’s Chief Investment Officer, Tom Joy. “Strong long-term investment returns and better, fairer and more sustainable outcomes for society go hand in hand. Our trustees are fully committed to resourcing engagement and other Responsible Investment activities as core strategic priorities.”
Outside of corporate engagement, the Church of England also employed divestment strategies to address environmental risks in its portfolio. The plan’s criteria for exclusion included those companies that derive more than 10% of their revenues from either the mining of thermal coal or the production of oil from oil sands.
The plan intends to implement further exclusions next year, which will be applied to companies that are not managing climate risk or planning to reduce emissions across their value chain as measured by the Transition Pathway Initiative (“TPI”). TPI is a global asset owner initiative co-led by the Church of England, focused on assessing companies’ readiness in transitioning to a low-carbon economy.
Across the pond, other divestment moves reverberated last month, when the University of California announced the removal of about $150 million fossil fuel related assets from its $13.4 billion endowment portfolio and $70 billion pension fund. The reason for the shake off? Fossil fuels posed long-term threats to generating strong returns, according to a L.A. Times op-ed coauthored by the plan’s CIO, Jagdeep Baccher, and Richard Sherman, chair of the UC Board of Regents’ Investments Committee.
“As it relates to addressing climate risk, we are seeing college and university endowment professionals, trustees and presidents move from the question ‘Why should we be doing this?’ to ‘Why aren’t we doing this?’,” observed Alice DonnaSelva, managing director of the Intentional Endowments Network (“IEN.”) IEN is a non-profit peer learning network of endowment stakeholders, financial services professionals and non-profits whose 160 members represent $2.5 trillion in assets. The network is hosting the 2020 Higher Education Climate Leadership Summit next February where college and university presidents, CIOs, and members of the investment community will gather to learn how to address climate risks and take advantage of opportunities in their investment processes.
Endowment stakeholders are also questioning how they can leverage their research into climate adaptation, resilience and solutions to uncover investment opportunities, added DonnaSelva. Further, pressure is mounting on investment managers, particularly those with longer time horizons regarding how they are managing climate risks in their portfolios.
Climate Risks Impact Asset Allocation
Some market participants are not only considering the impact of climate change on investments at the asset level, but are contemplating how environmental risks may affect investors’ approach to the broader portfolio. “A recent big focus for our asset allocation team has been a review of specific climate related issues and how they could impact various asset classes, regions, and sectors,” noted Scott Perry, partner at NEPC, a consulting firm that represents more than a trillion in assets.
The analysis came upon the request of the $3 billion Seattle City Employees’ Retirement System (“SCERS.”) The plan approached NEPC in April to better understand and educate SCERS’ board on the potential implications of climate change on its portfolio over the long-term. SCERS emphasized assessing such investment risks under different government policy scenarios that either somewhat or fully, addressed or ignored climate change.
While the results of the initial study have not prompted allocation shifts yet, it served as a first step towards awareness of future climate risks through a broader investment lens, noted Lynda Dennen, senior research consultant at NEPC. For example, emerging markets, particularly under a dystopian scenario, where there would be no government intervention to address environmental changes, would be very hard hit. Such economies may find it challenging to adapt to climate shifts, without policy support given the lack of available resources. “The unknown piece of the analysis is when markets are going to price in climate change risk,” added Dennen.
Going forward, NEPC intends to utilize the framework as another tool in its ESG kit when assessing managers’ climate awareness and due diligence processes.
Climate change was named among one of two major trends that will reshape asset allocation, in a separate study released last month by BNY Mellon and CREATE-Research. Future 2024: Future proofing your asset allocation in the age of mega trends approached global institutional investors who represented combined assets under management of about $12.75 trillion. About 93% of the respondents considered climate change a risk and 57% viewed changes in climate as both a risk and an opportunity. The study further indicated that future allocations may shift more towards private markets over public investors given the increased desire for uncorrelated absolute returns.
Some investors have already altered allocations to favor private markets due to the risks and opportunities associated with sustainability shifts. The $200 million Unitarian Universalist Association (UUA) gradually upped its investments in private debt, equity and real estate to currently represent to 5% of the portfolio with a target of 10%, from zero a few years ago, according to Tim Brennan, Special Advisor in Responsible Investing, at the UUA. NEPC also serves as the UUA’s consultant.
Changes to the investment portfolio stemmed from the UUA investment team’s desire to meet its fiduciary obligations. “We believe there is return opportunity in climate solutions” Brennan said. “If you look at the macro level of where the world needs to go, we are pretty far from reaching below 2ºC per the Paris agreement. The opportunities and risk in addressing climate change have not fully been valued.”
While the role as a fiduciary initially triggered the plan to address climate investment risks, the UUA also sought to better mission align its investment portfolio given its goals as a faith based institution. “Justice is part of every decision,” Brennan added. “We also look beyond the portfolio to understand how our decisions influence the broader society and discuss these potential implications with every manager we consider as well.”
Tom Joy echoed the immediate need to confront climate shifts.
“Climate change is unquestionably an investment risk and it is our fiduciary responsibility to address it. If the global average temperature rise is not restricted to well below 2ºC, it will cause economic, environmental and social damage that it will not be possible to avoid via asset allocation or investment selection,” he said.
“Whether investors come at climate change from a financial or ethical perspective really makes no difference: the need for urgent action is clear.”