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Climate Investing Isn’t ‘Woke Capitalism.’ It’s Smart Capitalism

Considering the risks climate change poses to investment portfolios is a fiduciary duty.
State Capitol Texas

By Thomas H. Stoner, Jr., and David Schimel, PhD

Climate-related risks have already cost American retirees billions in lost pension dollars — but try telling that to those crusading against “woke capitalism” in Texas and Florida.

Republican leaders in those states, who recently codified rules that ban money managers who consider ESG criteria from state pensions and other public entities, seem content to take a political stand while their constituents bleed money.

Based on yesterday’s arguments, such lawmaking might have been more salient in, say, 1950, when countries around the world, including the U.S., had not yet made commitments to decarbonize, and the large-scale transition to electric vehicles and other renewables was not already underway.

Environmentalists and progressives hooted and howled in reaction to the anti-ESG measures in Florida and Texas and those in Kentucky and West Virginia. We feel their pain, but in reacting emotionally, many of them also miss the point.

Here’s the real point: Climate change is coming for your portfolio, whether you like it or not. The reason fiduciary investors consider climate-related risks is simple: to protect investors as extreme weather events increasingly decimate real assets and climate-related regulatory changes worldwide leave people scrambling to adjust to legal requirements. Considering these factors saves pensioners and others money in the long run. It’s as simple as that.

We’re not writing this to stake a political claim but rather to make clear that sophisticated investment analysis demands consideration of material financial risks, including those posed by climate change, as well as wealth-creating opportunities, including those associated with the shift to a lower-carbon economy.

Leaders in Florida, Texas and elsewhere are fighting yesterday’s battle — imagining that ESG investing is still predominantly the “impact investing” of a decade or more ago — when divestment from fossil fuels, for example, was a matter of moral, not pecuniary intention. Politicians waging the ESG war today are either ignorant of what is happening in the market or intentionally conflating these investment styles.

Institutional investors, meanwhile, have moved on. When they pursue ESG investing, they apply sophisticated analysis to risk exposures. And the “physical risks” associated with rising sea levels, worsening monsoons and increasingly extreme weather patterns are hardly immaterial. These events damage real assets, supplies and equipment; disrupt supply chains and production; increase insurance costs — and more.

Investments also face “transition risks,” or policy risks, that arise as companies and others adjust to a lower-carbon economy, such as carbon pricing, liability costs, shifts in consumer preferences, and the cost of purchasing clean technology. Cutting emissions will reshape our global economy. It will re-price assets and redistribute resources. Policies intended to keep global warming below 2°C might make fossil fuels and related infrastructure at risk of becoming stranded.

Real assets, often seen as a hedge against inflation, are exposed to both types of climate risk due to their long hold periods, ability to be damaged by weather events, illiquidity and the fact that they contribute significantly to carbon emissions. With these assets representing a significant slice of pension funds in the U.S. — including up to 22% of the investments targeted by the Employees Retirement System of Texas — putting one’s head in the sand is not an option.

But the flip side of transition risk is transition opportunity. Investing in solutions that fuel the transition to net zero can be a wealth-creation vehicle. More than $8 trillion, or two-thirds of the world’s spending, on new power capacity over the next 25 years will go towards renewables, according to a Bloomberg New Energy Finance forecast. The climate adaptation market alone could be worth $2 trillion a year within the next five years, according to Bank of America.

Considering the risks and opportunities associated with climate change and the shift to a lower carbon economy is a crucial part of the investment process. Without such analysis, risk can be mispriced, leading to poor asset allocation decisions.

Climate change has been hard for the market to price, but it is already modifying investment decisions in various sectors and industries worldwide. To de-risk the global economy, financial markets must use information systems to evaluate and price physical and transition risks from climate change as each sector shifts to a low-carbon economy.

Putting a price on climate change systematically will ensure that politics don’t muddy the water when it comes to an issue like climate investment that directly impacts the future of our planet — and the bottom line.

(Thomas H. Stoner, Jr., and David Schimel, Ph.D., are, respectively, the CEO and Chairman of Entelligent, which models data to help investors make better decisions. Tom’s career includes financing and building several renewable energy projects worldwide and leading the London IPO of Econergy International. Dave is a senior research scientist at NASA Jet Propulsion Laboratory. For his work as IPCC Convening Lead Author, he participated in the Nobel Peace Prize in 2007.)