There are many reasons why investors may want to incorporate ESG funds in their portfolios, including the desire to pursue attractive risk-adjusted returns.
In the summer of 2018, wildfires raged across nearly 2 million acres of California. The fires were so numerous and widespread that the smoke plumes were visible from space. At the same time, a protracted drought saw the basin of the Colorado River, whose water serves 30 million people in seven U.S. states and Mexico, shrink past the 50% threshold relative to 2000 levels. Beyond calculating the immediate financial damage of these climate-driven changes, why should investors care?
Both of these events are signs of our spreading climate catastrophe. And by some accounts, these signs reveal a quickening in the pace of climate-change-related destruction. As individuals, we might feel powerless in the face of such large-scale forces, but the fact is that investors can take steps both to address the underlying problems and to mitigate the potential long-term impact on their investments.
Diversified portfolios may have concentrated climate risks
A portfolio that has not been constructed with a careful evaluation of environmental, social, and governance (ESG) risks generally will be quite vulnerable to those risks. Even broadly diversified portfolios invested in line with common U.S. benchmarks may include companies—particularly in sectors such as energy and information technology—that haven’t done a stellar job of insulating their businesses from the physical hazards of climate change or the eventuality of emerging climate policies that impose stricter rules on carbon emissions.
To the degree your portfolio contains businesses that are vulnerable to the future physical effects of climate change, as well as the policy risks that may arise for those companies if regulations evolve to meet climate challenges, then your portfolio will bear those vulnerabilities as well. And while these risks in the very short term may not affect the valuations of these companies, we believe that over time, these risks could be realized, with terrible effect, on any vulnerable company’s bottom line.
Making companies more climate resilient
At Trillium Asset Management, our environmental risk awareness is particularly attuned to companies that are large greenhouse gas (GHG) emitters. In line with that, we avoid investing in coal companies altogether, while with oil and gas companies we take a strong shareholder advocacy perspective, working with management to cut emissions. For example, we encourage natural gas drillers to reduce fugitive emissions at the wellhead, which is a sustainable way of cutting down on the release of methane—one of the worst industrial and agricultural intensifiers of the greenhouse effect—and we seek to help oil refiners make their existing processes cleaner.
Persistent engagement efforts
Water usage is also a critical area for improving environmental conditions and reducing environmental risks. Our engagement strategy regarding water usage in the semiconductor industry, for example, has led to tangible change. At semiconductor chipmaker Intel’s 700-acre manufacturing facility in south Chandler, Arizona, the rooms are sealed to prevent dust, debris, and other pollutants from damaging the chips. Clean air, and especially the lack of pollen, is the reason for the desert location. But huge quantities of water are also needed to manufacture chips. In 2018 alone, Intel used 12.8 billion gallons of fresh water—and common chip-manufacturing processes contaminate this water with heavy metals.
As investors in this company, we brought these water and waste issues to the attention of Intel’s board and began working with the company to improve its recycling efforts. Over time, we’ve helped foster a transformation of Intel’s water usage. In 2018, the company was able to filter and return 75% to 85% of its water back to municipal operations. The company is currently on track to restore 100% of its water use by 2025.
We've been in constant dialogue with Intel on a variety of issues since our first engagement. On the subject of GHGs, the company has committed to reduce its direct emissions by 10% on a per unit basis by 2020. It's also become a leader on the issue of conflict minerals—minerals that are sourced in countries experiencing violent unrest and whose sale helps perpetuate that unrest—and their use in the technology industries.
Another strand of our engagement with companies is resiliency and adaptation. An example here is our work with J.M. Smucker Company (Smucker’s). Originally a jam maker, the company acquired a major coffee brand from Procter & Gamble that catapulted it into the position of third-largest coffee seller in the United States. Coffee is a highly sensitive crop that requires a very narrow range of humidity, temperature, and rainfall to thrive. Any change to these variables could have potentially damaging effects to the company’s agricultural partners, not to mention Smucker’s balance sheet strength. We brought these risks to the Smucker’s board’s attention and we worked with them to make certain they’re prepared to address the relevant climate risks.
ESG risks considered holistically
Climate risk analysis is a critical part of our work, but we believe that social and governance issues are frequently enmeshed with environmental risks. For example, thinking through how climate change may affect a company’s operations must involve a consideration of supply chains, how more frequent severe weather events affect employees’ ability to get to work, corporate responsibility to ensure company resiliency, and other governance elements.
Considered globally, changing climate patterns are leading to more frequent flooding and crop failure due to drought, which is a leading cause of political upheaval, migration, and war. In this way, climate change is about much more than destructive fires or diminished water supplies. It can lead to profound social and economic disruption that cuts across all sectors and geographical boundaries.
While these considerations may sound dire, the global investment community is empowered to help change things for the better, both for investors and the broader community. Many companies themselves have demonstrated a commitment to more sustainable business practices. By committing to engagement and building stronger climate resiliency, investors can ensure such initiatives continue and that their portfolios are better braced for change.