Knowledge is Power: Improving Investment Options and Reducing Climate Risk for Individuals

Although 2020 was a bit different than previous years due to COVID-19, one thing that remained constant was the impact of a rapidly changing climate on our communities and economy. 2020 was another record-breaking year for climate-related disasters, whether extreme heat, hurricanes, or wildfires. These events are placing significant stress on our economy and industry resulting in reductions in profitability and earnings in companies. Beyond the physical risk, there is the transitional risk where fossil fuel-dependent companies are losing investments or possibly shuttering as the economy moves to decarbonize. Both physical and transitional risks are and will continue to impact investors.

Unfortunately, most individual investors are at a significant disadvantage when it comes to reducing climate risk in their investment and retirement portfolios. Climate conscious investors who see the growing risk do not have a clear guide or pathway to reduce this risk. Options for those looking to minimize climate risks in their portfolio are available. Environmental, Social and Governance (ESG) funds have been around for a while to provide more environmentally friendly options. However, there are no strict rules around investment options that make them officially “climate safe.” Without this direct guidance efficiently and effectively identifying the right investments is difficult. Only the most active and aware climate-focused investors will take the time to identify these climate-safe investments. This leaves a significant portion of the population greatly exposed to climate risk. Futher, to make matters a bit more difficult most of our company retirement plans have none or very few Socially Responsible Investing (SRI) or ESG focused funds. I work at an organization that conducts research on climate and sustainability, and our retirement options include one ESG fund.

A Path Forward for Investors

Do-It-Yourself: For personal investing, not related to your company’s retirement program, do some of your own “climate-safe” screening. This would include identifying and utilizing “climate-safe” filters, such as:

• Emissions profile, including energy use and source
• Geography: Different geographies have different risk profiles. Check out the most recent National Climate Assessment to get a general idea of geographic risk
• Industry: fossil-fuel focused or dependent industries face greater transition risk; supply chain and logistic risks
• Company investment and underwriting activity: Isthe organization supporting projects that promote global heating; does it disclose the existing and future transition and physical climate risk? The SEC reports of public companies can contain this information but it can be dense and opaque.
• Compliance with government environmental regulations

Some resources for this information include:

• Going directly to a company’s web site and checking out their latest ESG and CSR report.
• Carbon Disclosure Project (CDP). The CDP has developed a robust reporting framework that allows both the private and public sectors to manage, measure, and disclose their risks and opportunities to climate change. Globally 1,000s of private and public sector organizations submit data on a yearly basis. This database can help you begin to identify climate-safe companies to consider.
• Also, the CSRHUB would be another helpful resource to see the ESG score for companies. There is also the Global Reporting Initiative (GRI) Sustainability Disclosure Database.

Change Hearts and Minds or DIY: Talk with your company retirement administrator about identifying and providing climate-safe options. According to the Plan Sponsor Council of America, only 2.9% of all 401(k) plans have ESG funds. Because there is still some uncertainty as to what goes into an ESG fund and the criteria that places companies in an ESG fund, it will be difficult. Companies are risk-averse and are not likely to move from the status quo unless there are more clear criteria for these investment types. A more simple option would be to open up a self-directed brokerage option. Via your administrator, you can open up a brokerage window and choose your own funds.

New Sheriff in Town: With the new Biden administration there are a few things that can be done in the short to mid term. First, have the US Department of Labor roll back a recent regulation that negatively impacts the availability of ESG and SRI classified investments in your company-based retirement portfolio.

Also, there needs to be a more concerted effort to develop a clear, practical climate risk information-sharing framework that will improve reporting and disclosure of climate risk. As I mentioned above, the Carbon Disclosure Project has developed a robust reporting framework that allows both the private and public sector to manage, measure, and disclose their risks and opportunities to climate change. Globally 1,000s of private and public sector organizations submit data on a yearly basis. Unfortunately, you probably have never heard of it unless you are responsible for ESG or Corporate Sustainability Reporting (CSR). This is not to say this information is not being used in investment decision making. Large institutional investors and asset managers are starting to use this information. Knowledge of this information has led to divestment from certain industries and efforts to decarbonize investment portfolios. However, unless you are CalPERS, Blackrock, or a similar-type entity, you are most likely not aware of your climate risks when investing.

To improve transparency, the Security Exchange Commission (SEC) could adopt the CDP reporting framework and recommend its use. A concerted effort to explain the importance and benefit of such information sharing and transparency may result in greater participation by organizations. Further, by promoting such a framework the public is more aware and may use this information for investment and purchase decisions.

Another option is that the federal government, particularly the Federal Reserve and SEC adopt the recommendations of the Taskforce for Climate-related Financial Disclosure (TCFD). The TCFD is made up of an international group of banks and investors that have developed specific climate risk-related reporting criteria and rules for conducting climate risk scenario analysis. Many central banks and a multitude of organizations have signed on to utilize these criteria. The US is one of the key laggards.

To Conclude

At present, due to a lack of transparency, investors are not fully aware of their climate risk exposure in their investment portfolio. Some tools exist to identify options, but are severely limited. The United States must start taking proactive measures to better educate its investment community of the mid to long term climate risks of retirement investments. Expecting the market by itself to respond and adjust to this coming climate risk is not the path forward. The financial sector is too reactive and significant portfolio value will be lost before adjustments are made to mitigate this risk. The result is over-exposed, higher risk retirement portfolios. The data and models to inform better decision making are available, our financial sector and regulators need to work together to make sure it is available for all to use.