What the Paris deal means for fiduciary investors
Whether you consider the Paris climate agreement a historic success or an equally huge disappointment, one thing’s clear: it’s too big a deal for investors to ignore. That’s especially true for institutional investors, fund managers, and others with fiduciary obligations: with 196 nations now in agreement on the threat posed by climate change, it’s going to be difficult for such investors to justify turning a blind eye to climate risks. The agreement “sends a very powerful message to the business and investment community that the age of fossil fuels is ending,” says Alden Meyer of the Union of Concerned Scientists. “Continued investments in high carbon assets conflicts with their fiduciary responsibility.”
Climate campaigners have argued for years that fiduciary investors should be taking climate change seriously. As early as 2005, a report commissioned by the United Nations Environment Program concluded that factoring climate risks and other environmental factors into fiduciary decision-making “is clearly permissible and is arguably required in all jurisdictions”. But in recent years the specific risks associated with climate change — and their potential impact on fossil-fuel dependent businesses — have come vividly into focus.
In a report published last month, BlackRock warned that climate risks were growing, with long-term investors’ concerns about stranded assets and the potential for catastrophic losses of capital likely to lead to stocks in carbon-intensive industries trading at a substantial discount. “Climate change is creating increased levels of corporate risk, and that risk could well feed into substantive loss in the future,” explains Ewen Cameron Watt, global chief investment strategist for the BlackRock Investment Institute.
That realization is driving some institutional investors to edge away from carbon-intensive investments, and to explore more sustainable and resilient options. “Pension funds recognize their fiduciary duty to address climate risk and, where necessary, to reallocate investment away from high carbon-related activity likely to destroy shareholder value,” said Donald MacDonald, chair of the Institutional Investors Group on Climate Change, which represents funds managing a collective $14 trillion. “This is a matter of trying to protect your portfolio,” agrees Ulf Erlandsson, senior portfolio manager of global macro trading at the $36 billion AP4 fund. “As fiduciary investors, when there is a permanent capital loss in your portfolio – like stranded assets [that] will get written down – it should scare you.”
The Obama administration has been pushing fiduciaries to give more consideration to climate risk, with the Department of Labor issuing new guidance this fall about the degree to which the Employee Retirement Income Security Act (ERISA) permits fiduciaries to weigh environmental factors in their planning. Under the new guidelines, pension plan fiduciaries are expected to consider environmental and social risks that could reasonably impact an investment’s performance, and are encouraged to use environmental considerations as tie-breakers between otherwise equally promising opportunities.
Some analysts see the ERISA guidance as going too far, and leaving investors open to lawsuits if they invest in carbon-intensive industries. “This government is essentially saying: Don’t you dare invest in anything that causes or is hurt by climate change, or you’ll be sued for failing your fiduciary responsibilities,” warns former hedge-fund manager Andy Kessler. And while divestment might shield investors from risk, it isn’t likely to have much impact on the ways in which fossil fuel companies trade or run their operations. “As pension funds divest, hedge funds and other managers will gladly buy up undervalued climate-challenged companies,” Kessler argues.
Others, however, argue that the ERISA update simply makes clear what prudent fiduciaries already knew: that climate risks directly impact long-term returns, and hence should be part of any investor’s calculations. “Not only is it permissible for fiduciaries to incorporate sustainability into the capital allocation process, failure to do so may constitute a breach of fiduciary duty by intentionally overlooking the possibility of maximizing long-term risk-adjusted returns,” argue ex-veep Al Gore and his Generation Investment Management cofounder David Blood.
Fiduciaries who ignore climate risks could face payback sooner rather than later, according to a Generation Investment Management report, which predicts that carbon-intensive industries will reach a “tipping point” within the next five years that leads to stocks trading at significant discounts. Still, some companies could weather the coming storms better than others. BlackRock’s report, while stressing the risks associated with carbon-intensive industries, stopped short of urging investors to offload fossil-fuel investments. "The oil industry and energy-exporting countries may look like losers, yet low-cost operators should do fine as de-carbonization will likely be gradual,” the report noted.
Indeed, some investors are using their fiduciary duties to justify retaining fossil-fuel holdings, at least in the short term. A number of universities, under pressure to divest their endowment funds’ fossil-fuel assets, have cited their fiduciary obligations as a reason to avoid the potential losses they might incur by making a rapid switch to low-carbon investments. “Our endowment is overseen by the board of trustees, and they have a fiduciary responsibility not to take a hit,” said Tokumbo Shobowale, chief operating officer of the New School. “If you basically say, ‘I’m going to sell everything tomorrow,’ you take a hit.”
Such qualms mean that the most drastic efforts to excise carbon-intensive investments to date have been taken by funds that are ultimately under the control of politicians, not fiduciaries. California’s colossal CalPERS and CalSTRS funds are currently steamrollering through short-term fiduciary concerns, after California Gov. Jerry Brown signed a law in October mandating the funds’ rapid divestment of their coal investments. New York City Mayor Bill de Blasio is similarly pushing his city’s five public pension funds, which account for $160 billion in assets, to shed their coal investments.
In the long run, however, fiduciary investors are likely to become more decisive in their handling of climate risks. A recent Koskie Minsky report argued that pension funds’ fiduciary duties go beyond simply weighing climate risks, and also include the duty to “protect the longer term interests of their beneficiaries by acting as effective public policy advocates for climate change regulation.” Similarly, Christina Figures, the executive secretary of the United Nations Framework Convention on Climate Change, told delegates to the recent Fiduciary Investors Symposium that their active leadership was needed to demonstrate that “an orderly transition to climate neutrality is a path to prosperity.”
Clearly, not all fiduciary investors agree with Figures about their role in the climate debate, or about the best way for investors to move forward. Still, one thing is clear: after Paris, fiduciaries no longer have the option of simply ignoring climate risks.
Ben Whitford is the U.S. correspondent for The Ecologist. He has written for the Guardian, Newsweek, Mother Jones, Slate, and many other publications.