Investor attention to climate change, which cooled off considerably during the global financial crisis, is heating up again.
Institutional investors filed 147 climate-change-related resolutions by early June for the 2014 proxy season, compared with 110 last year and just 68 in 2009, according to Ceres, a Boston-based nonprofit that manages the Investor Network on Climate Risk. The network’s 110 members collectively manage more than $13 trillion in assets.
Although all the ballots hadn’t been cast by press time, some climate-related resolutions received support in excess of 30%. Their average vote received the past five years was 23%.
“Investors have raised the bar this year with asking companies to address climate risk,” says Rob Berridge, director of shareholder engagement for Ceres, which takes a very broad view of climate change. “The financial risks are pretty profound,” he says. “For example, the investment world is beginning to seriously worry about whether fossil fuel companies are overvalued.”
Shareholders filed resolutions with 11 companies this year, asking them how they will respond to a potential low-carbon future that could leave carbon assets stranded. Such assets account for a large part of their market value. A Ceres-coordinated effort also posed that question to dozens of other companies. The International Energy Agency has said that no more than one-third of proven fossil fuel reserves can be consumed before 2050 if global warming is to be limited to under 2 degrees Celsius. Over 100 countries adopted the 2 degree goal in the 2009 Copenhagen Accord.
Companies across multiple sectors also face financial risks tied to other climate-related matters including extreme weather, power plant emissions standards and other regulations, says Berridge.
He encourages paying attention to climate-related resolutions that are withdrawn—more than 60 this year—and not just those that go to vote. “Investors see them as victories,” he says, because companies made a commitment to do something that the investors requested.
John Willis and Bruce M. Kahn, portfolio managers at Sustainable Insight Capital Management, a New York-headquartered investment management firm founded in 2013 to help investors benefit from the transition to a more resource-constrained economy, also shared some thoughts with Financial Advisor.
Like much of their team, they hail from Deutsche Asset Management, where Kahn served as an investment strategist on sustainable investing and Willis served as the global head of trading, securities lending and research and head of the market research strategy investment team.
“One of the big trends that we’ve seen,” says Kahn, who has a doctorate in land resources and has focused on sustainability for 25 years, “is a shift on the part of investors that we call ‘moving from the moral to the material.’” What had been “very much of a cottage industry around moral, ethical screening,” he says, “has become more about accounting and financial material.”
Not only are asset managers and asset owners inquiring more about this, “The really promising thing is the reporting of ESG [environmental, social and governance] data is undoubtedly on the increase,” says Willis, who is based in Sustainable Insight’s London office. The EU has passed regulations that will require companies to disclose more nonfinancial information by mid-2014, and even China is demanding that industry report on greenhouse gases, he says.
In the U.S., the nonprofit Sustainability Accounting Standards Board is developing sustainability accounting standards to help publicly listed companies disclose material sustainability issues in mandatory SEC filings. “If it is relevant to a rational investor, then it is a done deal—no company will fail to release that information because they can be sued,” he says. “And once the financial markets have that information and are happy with it, they will use it.”
Sustainable Insight has already detected a link between climate-change engagement and financial performance through its September 2013 report with the Carbon Disclosure Project (CDP), a London-based nonprofit that provides a system for companies and cities to measure, disclose, manage and share vital environmental information. Out of a total 702 companies, those sorted into the top quintile based on CDP disclosure scores were found to offer a 5.2% higher return on equity, 18.1% more cash flow stability and 1.6% higher dividend growth than those companies in the lowest quintile.
“What was also interesting to us,” says Kahn, who co-authored the report, “is there was no discernable valuation premium yet ascribed by the market to those companies.”
Resolution Roundup
A closely followed shareholder engagement this year involved Exxon Mobil Corp. The company agreed to disclose its carbon asset risk, prompting Arjuna Capital and the nonprofit group As You Sow to withdraw their resolution, but then reported that none of its hydrocarbon reserves are or will become stranded because demand for fossil fuels is too great and governments are unlikely to greatly restrict hydrocarbon production.
“There’s a real disconnect between Exxon’s long-term business plan and what scientists are saying,” says Berridge.
Natasha Lamb, a portfolio manager with Arjuna and its director of equity research and shareholder engagement, says Exxon’s carbon asset report, the oil and gas industry’s first, is “a huge first step in the right direction and it shows a lot of leadership.” But she is disappointed. “Exxon’s decision to ignore that risk is quite myopic.” Arjuna, the sustainable wealth management platform of Baldwin Brothers Inc., a Marion, Mass.-based independent financial advisory firm, plans to continue its engagement with the oil company.
Michael Passoff, CEO of Proxy Impact, a San Francisco-based proxy voting and shareholder engagement service for foundations, NGOs and other mission-based or socially responsible investors, also weighs in. “I think investors will interpret this as Exxon taking a head-in-the-sand approach that will raise more concerns for shareholders and has likely assured that this issue will be back on their proxy next year,” he says. Meanwhile, he says a potential carbon bubble from overvalued assets has “huge financial implications for fossil fuel companies and investors in general.”
Another shareholder campaign that grew significantly this year asked companies to set greenhouse gas reduction targets, notes Passoff, co-author of Proxy Preview 2014, a joint report from As You Sow, Proxy Impact and the Sustainable Investments Institute (Passoff founded the decade-old publication). By its count, 34 companies faced such proposals, up from four in 2013. A dozen specifically dealt with methane.
Methane, the second-most-abundant greenhouse gas after carbon dioxide, has 86 times the latter’s global warming potential over a 20-year period, according to a 2013 assessment by the Intergovernmental Panel on Climate Change. “Methane may determine the fate of where natural gas is going to go,” says Passoff. Although viewed as a bridge fuel to alternative energy, it actually releases more methane in its operations than coal or oil, and the leaks at its drilling sites are a big problem.
He is also interested in resolutions asking banks how they evaluate greenhouse gas emissions in their lending policies. Such resolutions were filed this year with Bank of America and PNC Financial Services. “I would not be surprised if this resolution expanded its scope next year,” he says.
Aaron Ziulkowski, a senior ESG analyst with Boston-based Walden Asset Management, notes that reducing greenhouse gas emissions makes financial sense. In an article he penned in Proxy Preview 2014, he cites an analysis by McKinsey & Co., Deloitte Consulting and Point 380 that found U.S. companies could reduce emissions by 3% annually between now and 2020 and realize savings of $780 billion.
For its part, Walden has been engaging energy providers and energy users this year. “We think it’s important to develop lasting, viable long-term solutions to climate change to address both sides of the equation,” he says. “We’re specifically asking companies to up their game and set goals.”
Building Climate-Friendly Portfolios
One company that Walden filed a resolution with this year is independent oil and gas company Denbury Resources, which specializes in enhanced oil recovery operations. It injects natural CO2 and man-made CO2 captured from industrial facilities into older wells in mature fields to help enhance their production. “The company has a very clear, focused strategy and niche,” says Ziulkowski. Walden withdrew its resolution after Denbury agreed to adopt quantifiable goals for greenhouse gas emissions by later this year.
And Arjuna? “We’re focusing on efficiency across all sectors and solutions that are helping the economy become more sustainable,” says Lamb. Several holdings in the firm’s core U.S. equity strategy, all of which, she says, have strong governance profiles, are energy companies listed on the New York Stock Exchange: EOG Resources, Hess Corp. and Exterran Holdings.
EOG and Hess have very high profit margins (15.2% and 17.8%, respectively) and strong cash flow per share. Exterran, a small-cap natural gas services company, provides such services as air emissions control and leak detection—strategies that align with Arjuna’s shareholder engagements. Exterran expects to grow earnings 46.5% next year and has strong operating efficiency and technicals, she notes.
Arjuna also owns First Solar, a leading global provider of photovoltaic solar systems (listed on the Nasdaq) that does large-scale projects with utilities. Lamb describes it as “best in class” and says its return on equity (8.7%) and net profit margins (10.7%) are well above those of its peers.
Pax World Management LLC of Portsmouth, N.H., announced in May that the Pax World Growth Fund had divested its fossil-fuel holdings and will substitute investments in companies proactively looking to help solve global sustainability problems with climate change, water, food and health care.
“Divesting fossil fuels won’t punish portfolio performance,” says Joe Keefe, president and CEO of Pax World, pointing to studies on this topic. The fund won’t dramatically underweight energy, though, since it plans to add renewables. Pax World also thinks companies intent on improving global sustainability challenges will deliver stronger performance over time. “We’re not high-frequency traders,” he says, noting that many clients are saving for their children and for retirement, “and we like the long-term trajectory of these types of companies.”
Among the companies the fund has substituted for fossil fuel holdings are Cree, a maker of energy-saving light emitting diode (LED) products; BorgWarner, a producer of powertrain components that optimize fuel efficiency, reduce emissions and enhance performance; and Trimble Navigation Ltd., a maker of GPS technology that helps organizations such as corporate car fleets and farm operations monitor their environmental impact and use the data to improve efficiency and reduce carbon emissions.
Pax World now has two funds with no fossil fuel holdings at all, but it remains invested in such companies elsewhere so it can continue to engage them on their emissions disclosure and reduction, policies for stranded assets and public policy issues. “We think divestment alone is not the solution—it’s part of the solution,” says Keefe. Pax World is working on reducing the carbon footprint of all its portfolios and did carbon benchmarking last year with help from Trucost, an environmental data firm.
Sustainable Insight invests in public-equity securities. It declined to discuss specific holdings for compliance reasons, but Kahn says the firm feels very strongly about agriculture and food production. It looks at up to 100 different ESG factors for the companies it screens, analyzes this data for financial materiality and uses it to adjust its expected returns, he says. The data comes from multiple sources, including MSCI ESG, GMI, Sustainalytics, RepRisk and Bloomberg.
For those who don’t buy into the U.S. government’s recent climate change report or any other reports on the risks, Willis notes that the markets won’t wait for the debate to be settled. “You can get the purists who say that every scientific hypothesis has to be closed before we invest,” he says. “If you do that, you will miss the boat.”