By Alison McDermott, Practice Management, State Street; Brianna Roberts, SPDR Strategy and Research, State Street

Every year on April 22nd, we celebrate Earth Day. Last year’s Earth Day marked a historic milestone: 50 years of supporting environmental protection efforts. And while that is a pretty significant accomplishment, one could argue that this year’s observance calls for even greater recognition.

In a year confined to living and working from home, many of us turned to nature more than ever before as a means of escape. Long days spent indoors highlighted the importance, and increased our appreciation, of the environment’s great outdoors in a profound and impactful way.

With greater appreciation comes greater recognition – and action.

While the COVID-19 crisis could have knocked climate from the top of the ESG agenda, last year’s devastating weather events and record-breaking wildfires wreaked havoc around the world – shining a spotlight on climate change as an issue and putting global warming in its rightful place: the hotseat.

With a greater emphasis on living according to their values, investors are increasingly ready to take a stand with their investment choices. More and more investors are using their financial capital to drive impact and promote the kind of change they wish to see in the world – hopefully creating a greener and cleaner world.

We believe that now is the time to act and this is why we believe it is the time for ESG investing to move from a check-the-box component of investment portfolios to a key ingredient in portfolios.

From the Fringe to the Core – Climate Considerations Become Critical

As ESG has gained traction in the United States, investors have increasingly understood that sustainable investing not only offers a means to exercise personal values, but also a way to potentially mitigate long-term risk.

Universal climate change concerns have transformed in recent years, moving from a focus on the physical risks to our environment at a future date to immediate business, economic, and regulatory risks – accelerated by recent global events. We can no longer deny the real, tangible impacts of climate risk on investment portfolios, and we must take action now to reduce immediate climate threats and prepare for what is to inevitably come.

US ESG Fund Assets

 

Climate Impacts Cross Borders And Business Lines

To the chagrin of many investors who have kept sustainable investing off of their radar, there is no ‘one size fits all’ approach to climate investing. Depending on current portfolio exposures and anticipated investment outcomes, investors may look to mitigate ongoing risks and/or position portfolios for future adaption.

Perhaps the most apparent offenders are traditional energy companies, which have come under intensifying scrutiny for unsustainable operations – and for good reason. Aside from the obvious environmental destruction, traditional energy companies are likely to fall victim to changing societal preferences for clean energy and are extremely sensitive to reduced consumption of oil and gas. These companies face the likelihood of owning stranded assets – undeveloped reserves that may end up remaining undeveloped forever – that are detrimental to their near-and-long-term valuations. For example, Exxon Mobil wrote down $17 to $20 billion in value of natural gas reserves in 2020 alone, citing the sharp decline in demand and exorbitant project costs. However, even some of these companies are starting to take ownership in their climate roles, re-allocating resources to investments in cleaner technologies.

Scrutiny is no longer confined to the largest polluters. Across sectors and industries, we are seeing companies, both proactively and due to shareholder encouragement and regulation, take a climate lens down their supply chain for ‘hidden’ risks. For many, this includes infrastructure resiliency and business continuity strength to manage extreme weather and subsequent human capital impacts. Companies with climate-forward infrastructure and remediation plans, both physically and technologically, may be less likely to experience business disruptions as we continue to experience wild fires, deep freezes, pollution, floods, and damaging winds.

Establishing Climate-Conscious Portfolios

Investors have a myriad of options to address current climate risk exposures within their portfolios, from complete divestment to minimizing exposure.  Dependent upon overall portfolio exposures and risk budgets, investors have opportunities to negatively or positively screen out securities with undesirable exposures, such as sizable carbon footprints or fossil-fuel ownership.

Investors concerned with maintaining relative flagship portfolio exposures also now have more tools at their disposal to aid in rectifying climate risks. Benchmark-aware strategies provide the ability to target companies with, for example, smaller carbon footprints within a confined tracking error band to the flagship benchmark.

While addressing portfolio climate risks is an immediate action item for all investors, there is also considerable investment opportunity as the global economy begins to adjust to a more environmentally-conscious world.

Clean energy and power have soared in popularity in recent months, but this should not deter investors from considering an allocation to the space. Climate issues will progressively intensify without direct intervention and we cannot afford to view them as trendy market noise.

Investors should consider positioning their portfolios to benefit from broad adaption of clean and sustainable energy. This may include replacing or supplementing traditional energy exposures with companies dedicated to clean infrastructure, or overweighting technology companies committed to developing the software and services driving energy innovation and efficiency.

The Time to Act is Now

While climate investing trends have long been of interest to sustainability and impact investors, their momentum is likely to increase as climate becomes a critical facet of mainstream investment portfolios. The impacts of climate change are no longer abstract, distant worries – they are on our doorstep and portfolios must be prepared to weather the storm.

For more information on ESG investing opportunities, please visit our dedicated ESG webpage

Originally published by State Street


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