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Big investors are starting to sweat the details of climate risk

Only 7% of institutional investors in a new survey said they had done nothing to manage climate risks in last 5 years.
February 25, 2020

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Certain politicians may spout climate denial, but investment professionals with their eye on the bottom line share the scientific consensus about climate change: 97% believe that global temperature will rise by the end of the century, a new study reveals. Four in 10 think the temperature increase will exceed the 2 °C target set out in the Paris Agreement.

An international team of researchers designed a survey to suss out how climate change is shaping investment decisions. They delivered paper copies of the survey to attendees at investment conferences and invited others to complete the survey online. Altogether 439 people who work for institutional investors – meaning pension funds and the like that manage large sums of money – completed the survey.

One-third of the respondents were executives in their firms, reflecting that climate change has become a topic of C-suite importance, the researchers report in The Review of Financial Studies. The survey participants came from around the world but were concentrated in the United States and Europe. About one in 10 worked for institutions that have more than $100 billion in assets under management.

“Understanding the specific role of institutional investors is important, as they are increasingly viewed as catalysts in driving firms to reduce their carbon emissions and to prepare for a low-carbon economy,” the researchers write.

Their study suggests that institutional investing is on the cusp of a transformation due to climate change. Only 7% of the investors in the survey had done nothing to manage climate risks in last 5 years. But more than half of those who incorporate climate risk into their investment plans only started to do so within the past 5 years.

Investors have a variety of approaches to managing this risk and no particular approach is dominant across firms, suggesting that the industry is still working out best practices. The most common approaches are analyzing the carbon footprints and stranded asset risks of firms in their portfolio (38% and 35% of respondents reported using these approaches, respectively). Some also try to reduce portfolio firms’ carbon footprints (29%) or stranded asset risks (26%).

Out of a dozen different tools for managing climate risk, the least common is divestment, employed by just 20% of investors. This is particularly striking given the recent growth of fossil fuel divestment movements; for now, activists and institutional investors don’t appear to be on the same page.

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The survey also explored how investors communicate with companies in their portfolio about climate risk. Most investors – 84% – reported having undertaken such efforts in the last 5 years. “When investors engage portfolio firms over climate risks, they usually prefer private discussions with management,” the researchers write. 43% of survey participants reported using this approach, with 32% having suggested that firms take specific actions to manage climate risk.

Investors tend to take more public steps only when these behind-the-scenes discussions fail. About 30% of investors reported submitting proposals to shareholders about climate risk or voting against management due to climate risk concerns.

The survey participants said that portfolio firms responded about 70% of the time when investors raised concerns about climate risk. But this response usually just amounted to acknowledging the issue, rather than taking active steps to resolve it. And if investors were dissatisfied with a firm’s response, 40% of the time they just dropped the matter. Again divestment was rare, occurring in only 17% of cases.

This finding “is interesting in light of the debate about whether divestment or engagement is more effective in combating climate change,” the researchers write. “Most of our investors’ actions appear consistent with the view that divestment would reduce investor influence to improve climate policies.”

The investors believe that current stock prices do not reflect climate change risks. They think some industries are overvalued, albeit modestly. “Not surprisingly, the oil sector is considered as the most overvalued sector overall, followed by traditional car manufacturers and electric utilities,” the researchers report. On the other hand, the participants see renewable energy, water supplies and management, electric vehicles, and green technology as promising investment opportunities for the future.

Source: Krueger P. et al.The Importance of Climate Risks for Institutional Investors.” The Review of Financial Studies 2020. 

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