Since today is Earth Day, now may be the perfect time for investors to look at the core holdings in their portfolios and ensure that they’re being managed with an awareness of climate risk. At Morningstar, Jon Hale, director of sustainability research for the Americas at Sustainalytics, offers investors some ways to become more climate-conscious and align their investments with their concerns about the planet’s future.
According to Hale, climate risk comes at portfolios in two ways: transition risk and physical risk. Transition risk is about how companies are managing the shift away from using fossil fuels.
Morningstar’s carbon metrics are a good starting point for assessing a fund’s transition risk. Sustainalytics, a Morningstar company, evaluates transition risk as a degree to which a firm’s activities and products are aligned with the transition to a low-carbon economy.
Physical climate risk, meanwhile, is about how much companies are exposed to the direct risks of extreme weather events and of the long-term chronic effects of global warming. These physical manifestations of climate change can impact a company’s operations, its value chain, the health of its workforce, and the stability of its customer base.
So, to see if their funds are being managed with climate risk in mind, investors should scour their funds’ prospectuses, fund fact sheets, and websites for references to climate change. If they can’t find any, odds are that climate risk isn’t top of mind for the portfolio managers.
Investors should also consider funds that are explicitly climate-aware. They may have fossil-fuel-free, low-carbon, or broad environmental, social, and governance investment mandates. For example, State Street Global Advisors offers a suite of ESG-themed ETFs, including the SPDR MSCI ACWI Climate Paris Aligned ETF (NZAC) (formerly known as the SPDR MSCI ACWI Low Carbon Target ETF (LOWC)), the SPDR S&P ESG ETF (EFIV), the SPDR S&P 500 Fossil Fuel Reserves Free ETF (SPYX), and the SPDR MSCI Emerging Markets Fossil Fuel Reserves Free ETF (EEMX).
NZAC, which tracks the MSCI ACWI Climate Paris Aligned Index, is designed to support investors who seek to reduce their exposure to transition and physical climate-related risks and who wish to pursue opportunities arising from the transition to a lower-carbon economy in alignment with the Paris Agreement requirements.
EFIV follows the S&P 500 ESG Index, which is the ESG offshoot of the S&P 500. The fund is designed to deliver comparable industry exposures to the S&P 500, though the ESG fund holds 308 stocks and the parent index holds over 500. Members of the S&P 500 ESG Index must meet specific ESG requirements to be included in that index.
SPYX tracks the S&P 500 Fossil Fuel Free Index, a benchmark of companies within the S&P 500 that are “fossil fuel free,” defined as companies that don’t own fossil fuel reserves (thermal coal reserves, coal reserve byproducts, or oil or gas reserves). Top sector allocations of SPYX include information technology at 29.61%, consumer discretionary at 13.56%, and healthcare at 12.89%.
EEMX, which tracks the MSCI Emerging Markets ex Fossil Fuels Index, credibly excludes fossil fuel stocks, as the energy sector represents only 0.41% of the ETF’s portfolio. The fund features exposure to five Latin American countries, including Brazil and Mexico, the region’s two largest economies.
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