A comprehensive climate change report released Monday that raises dire warnings about the Earth’s temperature has implications for the recommendations that advisers make for their clients.
The report comes amid a severe drought in the American West and one of the worst wildfire seasons in California’s history. In the extensive paper, issued by the United Nation’s Intergovernmental Panel on Climate Change, scientists from countries around the world concluded that humans have changed Earth’s temperature by more than 1 degree Celsius and will likely continue to do so rapidly, barring major changes to fossil fuel use.
“It is unequivocal that human influence has warmed the atmosphere, ocean and land,” the report stated. “Widespread and rapid changes in the atmosphere, ocean, cryosphere and biosphere have occurred … Each of the last four decades has been successively warmer than any decade that preceded it since 1850.”
That wording is significant, as the UN’s reports are conservative and based on consensus, said Jon Hale, head of sustainability research for the Americas at Morningstar.
“They made some of their boldest statements ever about climate change. It’s something to take heed of,” Hale said.
Climate change will undoubtedly affect major industries, and it is crucial that advisers stay informed so that they can educate clients about risks, said Jennifer Kenning, CEO at Align Impact.
“They have a fiduciary obligation, from my perspective, to bring it up. But you can’t bring it up if you don’t have a solution,” Kenning said.
That can include showing a client how exposed to climate risk their portfolio is, based on carbon intensity, and offering them an alternative. But that doesn’t mean selling all holdings in energy companies, as it is more important to consider the roles that today’s companies will have in a low-carbon economy in the near future, Kenning noted. Engaging with publicly traded companies through proxy voting is part of that.
“This isn’t a game of completely divest and get rid of the big dogs. This is a game of changing behavior,” Kenning said.
To start, advisers should “figure out where you stand as an independent adviser and where you stand as a firm,” and then look at how clients’ portfolios could best handle a shift to a low-carbon-emission world.
CONVERSATIONS WITH CLIENTS
Conversations with clients do not need to be alarming, Kenning said. Instead, they can begin with the question: “Do you care about climate?”
“This isn’t just nice-to-have anymore. This is imperative for generations to come,” Kenning said.
For some clients, the evidence is right outside their windows.
“The Bay Area has had record-breaking hot days year after year, and once again we’re experiencing a drought in the middle of wildfire season, so climate change is particularly concerning for many of my clients,” said Stanley Himeno-Okamoto, founder of San Francisco-based DRS Financial Partners, in an email. “They’re increasingly aiming to invest in ways that generate comparable returns while aligning their money with their values.”
Environmental, social and governance concerns are also receiving a lot of attention from regulators such as the Securities and Exchange Commission and Department of Labor, as well as from Congress.
“The SEC has already indicated increased scrutiny on ESG practices as the space becomes more popular, and for investment managers, not incorporating client values in portfolios could alienate a growing number of potential clients,” Himeno-Okamoto said.
It’s also a topic of concern for clients who aren’t necessarily worried about the environment, wrote Nate Nieri, founder of Modern Money Management, in an email.
“There is still a genuine monetary benefit for those who are not active in environmental and social change and should consider ESG investing,” Nieri said. “Companies that are adapting and preserving resources are in line to be industry leaders in their fields. Those who do not or are slow to change will be left behind, just as history has shown repeatedly.”
But some are unconvinced.
“I believe everyone wants to do good, and help the planet, but most don’t want to sacrifice their financial future for it, and they shouldn’t,” wrote Kyle Hill, founder of Hill-Top Financial Planning, in an email. “You might be inclined to build an ESG portfolio or use some ESG funds, but who decides what those standards are? I’m guessing in most cases, it’s not the client.”
Hill said he recognizes that climate change has happened but does not see compelling evidence that there is irreversible damage or that it is likely the civilized world will end. Technology such as nuclear energy, which can be used in place of fossil fuels, is wrongfully being ignored, he said.
“I have real concerns about the whole ESG movement and the government attempting to push ESG reporting on companies,” he said.
A MULTITUDE OF RISKS
Risks tied to climate change do not pertain only to energy companies, Morningstar’s Hale noted.
“Virtually every industry has some exposure to transition risk,” or that related to the move to a low-carbon economy, he said.
The physical location of a company could be a risk, and there are implications for the real estate market and supply chains, he noted. That also presents risks to insurance and banking.
Investors “have made it pretty clear that they’re concerned about climate risk, that ESG, in general, is appealing to them.”
Advisers and investment managers should “do the prudent thing on behalf of end investors, which is to take account of climate risks,” he said. “Today, if you can’t in one click get to an asset manager’s website that says, ‘here’s what we’re doing about climate risk,’ then they probably aren’t doing enough.”
Although there has been an incredible rise in ESG investing, and hundreds of sustainable funds are available in the U.S., the use of index funds presents its own challenge, he noted.
“The only way an index fund can address it is through shareholder engagement — there’s no other way,” Hale said. “That’s really important. Index funds should be on the front line.”
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Andrew is half-human, half-gamer. He’s also a science fiction author writing for BleeBot.