How Can Investors Tackle Climate Change?

We are in a race against time to tackle climate change, BMO chairman Jeremy Grantham warns, but investors can still effect change

Jon Hale 28 June, 2018 | 7:15AM
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Fossil fuel power station

We are in the “the race of our lives” to stave off the worst effects of climate change, GMO founder and chairman Jeremy Grantham has warned. While greener technologies and renewable energy are helping to decarbonise the global economy, climate change now appears to be happening faster than expected, Grantham said. Thus, it’s a race against time to mitigate the destabilising consequences of global warming.

Against that rather dire backdrop, what should investors do to become more climate-aware and to have an impact on the outcome of "the race of our lives"? Grantham mentioned three things investors can do: divest from fossil fuels, invest in green solutions, and encourage corporate sustainability in the companies they own.

Divesting Energy Doesn’t Hurt Performance

Grantham and his colleagues at GMO looked at what happens when you remove a single sector from an S&P 500-based portfolio. They created S&P 500 portfolios excluding energy, going back to 1989, 1957, and 1925. The ex-energy portfolio underperformed the S&P 500 by just five basis points on an annualised basis from 1925 to 2017 and underperformed by seven basis points annualised from 1957 to 2017. Over 28 years, the portfolio excluding energy outperformed: the S&P ex-energy portfolio rose by 9.74%, compared with 9.71% for the portfolio including energy.

"You can divest from oil – or about anything else – without much consequence for performance," was Grantham’s view. Yet today, the rationale for divesting from fossil fuels isn't just about aligning with an investor's values, it reflects a forward-looking view that these industries are in long-term decline and their reserves will become stranded assets.

"Oil may have a last hurrah before the electric cars arrive, but when they do, there will be some tough times for a long time," Grantham said.

While some funds advertise themselves as fossil-fuel-free, Morningstar's new carbon metrics can help you identify fossil-fuel-free portfolios. We calculate every equity portfolio's exposure to fossil fuels on an asset-weighted basis to reflect holdings that are involved in thermal coal extraction or power generation and oil and gas production, products and services, and power generation.

Morningstar analysts now offer a low carbon designation for retail funds in the UK. This rating, which sits alongside the sustainability scores on a fund page, allow investors to find funds whose investee companies are positioned for the transition to a low carbon environment.

Investing Changes Behaviour

There are areas of the market particularly vulnerable to climate change – namely, those reliant on fossil fuels – and there are pockets of the market that are generating the green solutions necessary to decarbonise the economy and respond to the challenges posed by global warming. But there is a third way that involves encouraging companies across the economy to be more sustainable. That means encouraging a change in the corporate mindset away from short-termism and abdication of responsibility for externalities to one focused on long-term sustainability and positive impact.

How can you do that as a fund investor? You can use the Morningstar Sustainability Rating to evaluate the funds you own or are considering for purchase. A fund with five globes is one whose underlying holdings score better relative to its peers on the set of environmental, social, and corporate governance issues material to their businesses. You can look for funds with four or five globes and avoid those with one or two globes. The globe rating is a useful starting point for embedding sustainability into your portfolio.

You can also invest in funds that have a sustainability mandate enshrined in their prospectuses. While they vary in their specific approaches, these are funds that are consciously incorporating sustainability – also known as environmental, social, and governance or ESG – criteria into their investment processes.

Many of them also actively engage with the companies they own to directly encourage more sustainable behaviour. In so doing, these funds, along with many other large institutional investors, are helping provide the space for corporate executives to think long-term, think sustainably, and think about their firms' impact on society and the environment.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Jon Hale  Jon Hale is a consultant with Morningstar Institutional Investment Consulting.

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