1. Growing Climate Risk
The biggest sustainability challenge the world faces today is global warming, and two reports released this fall underscored its magnitude. The report of the Intergovernmental Panel on Climate Change, written by scientists convened by the United Nations and released in October, finds that the world is currently on a path to warm by 1.5 degrees Celsius above preindustrial levels by about 2040, increasing risks to “health, livelihoods, food security, water supply, human security, and economic growth.” The report estimated the global economic impact at $54 trillion, growing worse over the course of the century if warming continues to increase.
The IPCC report was followed in November by Volume 2 of the latest National Climate Assessment focusing on the impacts of global warming in the U.S., which reached similar conclusions: “Climate change creates new risks and exacerbates existing vulnerabilities in communities across the United States, presenting growing challenges to human health and safety, quality of life, and the rate of economic growth.”
Climate change topped the list of ESG issues that concern asset managers in the U.S. SIF Foundation’s biennial Report on U.S. Sustainable, Responsible, and Impact Investing Trends. Just last week, the Institutional Investors Group on Climate Change, a group of 415 asset managers and pension funds with $32 trillion in assets under management called on governments to do more to combat climate change, including a commitment to accelerate private sector investment into the low carbon transition and to improve climate-related company financial reporting.
Investors need companies to disclose their assessment of the climate-related risks they face and how they plan to mitigate those risks. Many companies face significant carbon risk, which means they are significantly exposed to fossil fuels in their operations or product usage. Investors need to evaluate whether those companies can survive the transition away from a fossil-fuel-based economy and how they plan to do so.
While carbon risk is a material concern for some companies, the growing physical risks of climate change are becoming material concerns for others. These are the impacts on a company’s assets, operations, customers, and product use owing to more-extreme and more-frequent extreme weather events and from longer-term climate changes. Schroders estimates the potential costs to some companies of insuring their assets against the physical risks of climate change amounts to more than 4% of their market values.
If you are not sure about why investors ought to be concerned about climate change, I recommend Jeremy Grantham’s white paper that is based on his speech at this year’s Morningstar Investment Conference. I outlined three ways to follow Grantham’s advice on climate-aware investing in this article and explain our Morningstar Carbon Risk Score here. The latter allows you to evaluate the carbon-risk exposure in your portfolio.
2. BlackRock’s Commitment to Sustainable Investing
The year 2018 kicked off with the head of the world’s largest asset manager, Larry Fink, sending an open letter to corporate CEOs, urging them to think long term, act in ways that will benefit all stakeholders, and focus on how their firms make a positive contribution to society.
In response, a few pundits dragged out Milton Friedman’s half century-old dictum that the social responsibility of business is to maximize profits. But they missed the point of the letter. Fink was not exhorting CEOs to spend money on corporate feel-good projects. He was urging CEOs to position their businesses for long-term profitability by keeping their focus on a bigger picture, one that recognizes companies focused on minimizing negative environmental and social impacts and accentuating positive ones will be rewarded by increasingly aware customers, protect their brand, and attract top talent, enabling them to better navigate the transition to a low-carbon digital economy.
I don’t know of a single corporate CEO who spoke out against Fink’s letter. Having more investors focused on sustainability gives them the space they need for bigger-picture thinking.
By August, Fink was telling the Financial Times that “Sustainable investing will be a core component of how everyone invests in the future” and that BlackRock intended to be a leader in the space. The firm had already stepped up its engagement on ESG issues with companies, and during the year it began to share more information with its investors about those efforts.
The firm also rolled out three new iShares exchange-traded funds for U.S. investors: iShares MSCI USA Small-Cap ESG Optimized ETF (ESML), iShares ESG U.S. Aggregate Bond ETF (EAGG), and iShares Global Green Bond ETF (BGRN), bringing the firm’s ESG ETF lineup to 13. It is now possible to construct a diversified ESG portfolio for virtually any asset allocation using iShares ESG ETFs.
The third thing about sustainable investing this year is stewardship: how investors engage with the companies they own and how they vote in the proxy process. It’s an element in each of the first two things. First, investors are increasingly engaging with companies, asking them to disclose climate-related risks. Second, BlackRock has ramped up its stewardship activities, arguing that as a permanent owner of capital owing to its size and proportion of passive assets, the only way it can really influence companies–and add long-term value for its investors–is through engagement.
Shareholder resolutions about ESG issues have grown more frequent, and the level of shareholder support has increased, reaching an all-time high in the 2018 proxy season.