How climate resilient is your portfolio?
There are many reasons why investors may want to incorporate ESG solutions in their portfolios, including the desire to pursue attractive risk-adjusted returns. In this article, Cheryl I. Smith, Ph.D., CFA, portfolio manager of John Hancock ESG Large Cap Core Fund, discusses the landscape of risk and opportunity from the viewpoint of a dedicated ESG strategy.
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The numbers show that large-scale climate-related events are intensifying and becoming more frequent, which may have significant economic repercussions.
The financial impact of climate change
Environmental, social, and governance (ESG) concerns are changing how people think about their investments. Financial advisors are tapping into this change and finding a transformative opportunity: helping their clients make a difference in—and with—their portfolios. In this multimedia report, John Hancock Investment Management explores how and why ESG investing is building momentum around the United States.
Engaging your clients on climate change
How much do you know about climate change?
For each managed product, including mutual funds, variable annuity and variable life subaccounts, exchange-traded funds, closed-end funds, and separate accounts, with at least a 3-year history, Morningstar calculates a Morningstar Rating™ based on a Morningstar Risk-Adjusted Return that accounts for variation in a fund's monthly excess performance, placing more emphasis on downward variations and rewarding consistent performance. Exchange-traded funds and open-end mutual funds are considered a single population for comparative purposes. The top 10.0% of funds in each category, the next 22.5%, 35.0%, 22.5%, and bottom 10.0% receive 5, 4, 3, 2, or 1 star(s), respectively. The overall Morningstar Rating for a managed product is derived from a weighted average of the performance figures associated with its 3-, 5-, and 10-year (if applicable) Morningstar Rating metrics. The rating formula most heavily weights the 3-year rating, using the following calculation: 100% 3-year rating for 36 to 59 months of total returns, 60% 5-year rating/40% 3-year rating for 60 to 119 months of total returns, and 50% 10-year rating/30% 5-year rating/20% 3-year rating for 120 or more months of total returns. Past performance does not guarantee future results. ©2019 Morningstar. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete, or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information.
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As general awareness of environmental, social, and governance issues spread, people are asking how they can use their own investments to make a positive impact in order to help their own families, future generations, and society as a whole. Advisors can use our brochure to access all the information they need to answer clients’ questions.
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ESG in action: seven RIAs discuss ESG opportunities
Houston, Texas
Concord, Massachusetts
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Chicago, Illinois
Large company stocks could fall out of favor. The stock prices of midsize and small companies can change more frequently and dramatically than those of large companies. Foreign investing, especially in emerging markets, has additional risks, such as currency and market volatility and political and social instability. A portfolio concentrated in one sector or that holds a limited number of securities may fluctuate more than a diversified portfolio. Hedging and other strategic transactions may increase volatility and result in losses if not successful. Illiquid securities may be difficult to sell at a price approximating their value. Fixed-income investments are subject to interest-rate and credit risk; their value will normally decline as interest rates rise or if an issuer is unable or unwilling to make principal or interest payments. Mortgage- and asset-backed securities may be sensitive to changes in interest rates and may be subject to early repayment and the market’s perception of issuer creditworthiness. Municipal bond prices can decline due to fiscal mismanagement or tax shortfalls, or if related projects become unprofitable. The interest earned on taxable municipal securities is fully taxable at the federal level and may be taxed at the state level. Liquidity—the extent to which a security may be sold or a derivative position closed without negatively affecting its market value, if at all—may be impaired by reduced trading volume, heightened volatility, rising interest rates, and other market conditions. Fund distributions generally depend on income from underlying investments and may vary or cease altogether in the future. A fund’s ESG policy could cause it to perform differently than similar funds that do not have such a policy. Please see the funds’ prospectuses for additional risks. John Hancock Investment Management Distributors LLC • Member FINRA, SIPC • 200 Berkeley Street • Boston, MA 02116 • 800-225-5291 • jhinvestments.com NOT FDIC INSURED. MAY LOSE VALUE. NO BANK GUARANTEE. NOT INSURED BY ANY GOVERNMENT AGENCY 944160 12/19
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MORNINGSTAR RATING
Overall out of, 1208 funds in the large blend category as of 1/31/2020. Overall rating is based on 3-, 5-, and 10-year Morningstar Risk-Adjusted Returns and accounts for variation in a fund’s monthly performance. Other share classes may be rated differently. All funds may experience periods of negative performance.
In the summer of 2018, wildfires raged across nearly two 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 events, why should investors care? These extreme heat events—one fast moving, deadly, and shockingly destructive; the other slower moving but potentially far worse in terms of its long-term human, environmental, and economic impact—are just two of the latest 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 help mitigate the potential long-term impact on their investments.
Diversified portfolios may have concentrated climate risks
A portfolio that hasn't 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.
Cheryl I. Smith, Ph.D., CFA
Portfolio Manager, Trillium Asset Management
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 worst industrial and agricultural intensifiers of the greenhouse effect—and we seek to help oil refiners make their existing processes cleaner.
Making companies and portfolios more climate resilient
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 a 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, and 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 important 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 worked with them to make certain they’re prepared to address the relevant climate risks.
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.
ESG risks considered holistically
ESG investing | Combining financial returns with positive impact
Learn about best practices for combining ESG in your clients' portfolios.
Large company stocks could fall out of favor. The stock prices of midsize and small companies can change more frequently and dramatically than those of large companies. Foreign investing, especially in emerging markets, has additional risks, such as currency and market volatility and political and social instability. A portfolio concentrated in one sector or that holds a limited number of securities may fluctuate more than a diversified portfolio. Hedging and other strategic transactions may increase volatility and result in losses if not successful. Illiquid securities may be difficult to sell at a price approximating their value. Fixed-income investments are subject to interest-rate and credit risk; their value will normally decline as interest rates rise or if an issuer is unable or unwilling to make principal or interest payments. Mortgage- and asset-backed securities may be sensitive to changes in interest rates and may be subject to early repayment and the market’s perception of issuer creditworthiness. Municipal bond prices can decline due to fiscal mismanagement or tax shortfalls, or if related projects become unprofitable. The interest earned on taxable municipal securities is fully taxable at the federal level and may be taxed at the state level. Liquidity—the extent to which a security may be sold or a derivative position closed without negatively affecting its market value, if at all—may be impaired by reduced trading volume, heightened volatility, rising interest rates, and other market conditions. Fund distributions generally depend on income from underlying investments and may vary or cease altogether in the future. A fund’s ESG policy could cause it to perform differently than similar funds that do not have such a policy. Please see the funds’ prospectuses for additional risks.
Overall out of, 1208 funds in the large blend category as of 1/31/2020. Overall rating is based on 3-, 5-, and 10-year Morningstar Risk-Adjusted Returns and accounts for variation in a fund’s monthly performance. Other share classes may be rated differently. All funds may experience periods of negative performance
Diversification does not guarantee a profit or eliminate the risk of a loss.
1: https://www.nasa.gov/image-feature/goddard/2018/near-two-million-acres-on-fire-in-the-united-states
2: https://www.theguardian.com/environment/2015/may/17/lake-powell-drought-colorado-river
2
1
Summer wildfires rage in California
area scorched by Mendocino Complex fire in September 2018
450,000 acres
$85 billion
cost to U.S. economy of 2018 California wildfires (est.)
6 of the 10
largest wildfires in California history have occurred in the past decade
5°F
amount by which the state of California was warmer than normal during July 2018
U.S. heat waves
Heat wave season (days)
0
10
20
30
40
50
60
70
1960s
1970s
1980s
1990s
2000s
2010s
1. www.theatlantic.com/science/archive/2018/08/why-this-years-wildfires-have-been-so-ferocious/567215/ 2. https://earthobservatory.nasa.gov/images/92678/the-scars-of-mendocino 3. www.accuweather.com/en/weather-news/devastating-california-wildfires-predicted-to-cost-us-economy-85-billion-containment-may-take-weeks/70003000
Billion dollar weather/climate events rising in frequency
1980–2019 year-to-date U.S. billion dollar disaster event frequency (CPI-adjusted)
Number of events
4
6
8
12
16
Jan
Feb
Mar
Apr
May
Jun
254
total weather and climate disasters sustained by the U.S. since 1980 where overall damages/costs exceeded $1 billion (CPI adjusted)
6.3
annual average of billion dollar weather/climate events from 1980–2018 from 1980–2018
$1.7 trillion
total cost of these 254 events
1. www.ncdc.noaa.gov/billions
12.6
annual average for the most recent 5 years (2014–2018)
14
Jul
2008
Hurricane season losses are intensifying
15
number of named storms during 2018 hurricane season (11.6 average from 1950–2018)
1. www.munichre.com/topics-online/en/climate-change-and-natural-disasters/natural-disasters/storms/ typhoons-and-hurricanes-in-2019 2. www.munichre.com/topics-online/en/climate-change-and-natural-disasters/natural-disasters/storms/ hurricane-season-09-2018
hurricanes in 2018 (6.3 average from 1950–2018)
Rising inequality: the poorest states will be hurt the most
4%
annual percentage of GDP the median American county stands to lose to climate related events by the end of the century under current global warming scenario
1. www.economist.com/graphic-detail/2019/03/05/climate-change-will-affect-more-than-the-weather 2. static1.squarespace.com/static/55667009e4b04bbb290cc837/t/5b6b13098a922dee4a0ffb26/ 1533743898517/Science-2015-Hsiang-Kopp-Jina-Rising.pdf
10%
annual percentage of GDP lost under current scenario in particularly poor regions (i.e., counties around the fifth percentile of the national income distribution)
0.7%
annual percentage of GDP lost under current scenario by richest counties (i.e., those in 95 percentile of income)
$230 billion
2017’s record losses from North Atlantic hurricanes
Event statistics are added according to the date on which they ended
2011
2016
2017
2018
2019
Average
Aug
Sep
Oct
Nov
Dec
Statistics valid as of April 9, 2019.
Overall losses for tropical cyclone events
US$ billion
100
150
200
250
300
Nominal
1980
1985
1990
1995
2000
2005
2010
2015
Inflation adjusted (in 2017 values)
Normalized (in 2017 values)
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Making a difference in your portfolio
th
3
https://www.globalchange.gov/browse/indicators/us-heat-waves
Clients are looking to incorporate their own criteria in their portfolio’s investment thesis. This is particularly taking off as millennials want to see tangible effects of their actions.
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Investing in funds that promote environmental, social, and governance (ESG) issues is more than just a way to feel good about where your hard-earned saving go to work; socially responsible, investing may also make good economic sense. Explore John Hancock Investment Management's website to learn more about the benefits of ESG investing and our lineup of ESG funds.
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There is now a huge amount of interest in ESG investing as clients demand that all aspects of their life and investments align with their core values.
Interest in ESG is exploding
ESG offers investment managers a rich data set that must be integrated into investment processes, although doing so is not easy. It's essential for advisors to have their own clear assessment of the importance of ESG in order to communicate its value to clients.
Wealth of information brings opportunity and challenges
ESG investing can become a core element in an advisor's business, but the key is to be able to engineer specific solutions geared toward clients’ needs.
ESG investing can be a central pillar of a business
Victor A. Orozco
Partner and Director of Operations, Bair Financial Planning
5 years in ESG and I’d say fairly far along. We used some Socially Responsible Investing strategies for probably 8 to 10 years.
When did you begin investing in ESG strategies, and how far along do you feel you are in terms of your objectives in this area?
With the mass flood of fund companies getting into the space there will be a need to determine more “ESGish” managers and companies through proxy voting. I also see third-party verified self-reporting improving scoring metrics. Improved advisor education on the differences between SRI and ESG could also potentially lead to greater adoption through passive products as a lower-risk method focused on tracking error versus going high active share with fund companies focused on active management. There won't be a race to zero for fees and I believe there is a premium to pay, but we could see expense ratios come down a bit more.
How do you see the area of ESG investing developing over the next 3 to 5 years?
Yes, absolutely–I truly believe it's a distribution problem and not a consumer problem. To generalize in my opinion, the demographic of advisors means they don't think it is important to bring up the conversation nor do they want to bring it up. I feel they're scared and don’t want to go there. ESG/sustainability hits all demographics.
Do you think ESG spans different age ranges/demographics?
Yes, I think there is regional variation. For us, water/environmental sustainability, worksite benefits for LGBTQ employees, and diversity are all key areas.
Do you think there is regional variation in terms of interest in ESG, and what are the key areas of interest in your region?
We have firmwide models (active and passive) that solely utilize ESG solutions.
How do you integrate ESG into your investment processes?
One challenge is education on what ESG actually is. Secondly, the risk of the advisor community “overselling” performance and values of ESG. There is also the risk of fund companies entering the space that may discredit the hard work of previous ones that solely focus in ESG. Finally, getting funds approved on BD platforms and fiduciary arguments in retirement plans are potential challenges.
What are the biggest challenges for ESG investing going forwards?
James Werner
Partner, Wealth Advisor, Silicon Hills Wealth Management
We began investing in ESG a little over 15 years ago by replacing some of the traditional index fund options with the initial socially responsible funds. Socially Responsible Investing at that time was more about excluding the bad stuff, alcohol, fire arms, oil and gas exploration, etc., and less about promoting particular initiatives. Those came a bit later in terms of alternative energy, water, etc., that took the concept of sector funds into the ESG realm. We still have a long way to go with ESG. One area where we have excelled in is the allocation of donor-advised funds into ESG. There is a very strong correlation with our more philanthropic clients and the concept of ESG investing. ESG and donor-advised funds are such a natural combination. In the broader context, we still have trouble putting together a true ESG solution that we feel is competitive based on performance and fees, but the gap is closing.
I expect that we'll see the trend continue of implementing more ESG inclusive options. Gender diversity funds, climate change (carbon, renewables, water), will continue to be huge. I also expect that for ESG purists, we'll see more separately managed accounts where the holdings are more transparent and the end investor has ultimate control over whether they are included. Another interesting trend that I expect to continue and gain serious headway is the concept of incorporating ESG in some form into a traditional fund. We’ll see new issues with an ESG guiding principal that aren’t necessarily ESG first and foremost. We’ll also likely see more traditional investments incorporating ESG filters into their traditional models, creating more of an ESG hybrid that appeals to the traditional investor.
How do you see the area of ESG investing developing over the next three to five years?
Absolutely. I think the expectation for ESG as a part of the overall investment strategy is higher in the younger demographic or at least the awareness of it is higher, but the concept is embraced across all age ranges. To be clear there are clients who view their investing and their ESG duties separately and are less inclined to want to bring the two issues together, but we're seeing more and more a willingness to include ESG or an increase in asking for ESG investment solutions.
Yes! This is the one common refrain I hear with regard to ESG. Where you are in the country probably is a better indicator of your preference for ESG than anything else. In Austin, Texas, ESG is commonly accepted and even those who prefer not to engage in a full ESG strategy, appreciate understanding the options available to them. My colleagues in other parts of the state indicate that the ESG conversation isn’t as a natural. The reasons behind it are beyond my pay grade but they do exist. That’s one of the reasons why I believe the hybrid ESG concept will catch on faster, because I think it will be more readily adoptable across all regions.
ESG is still largely an exception processing thing for us. We have our traditional models and then we have ESG alternatives for some of the equity components. The vast majority of our donor-advised fund clients select the ESG option, but outside of that, we have traditional investment portfolios with ESG components. That’s probably why the hybrid options interest us like they do.
ESG’s two biggest challenges are 1) being ESG enough to satisfy the purists–this is tough because ESG is a subjective concept at some level. One bad apple may literally spoil the whole portfolio. 2) The difficulties achieving economies of scale for new entrants to the market. It's tough to get attention without a marketing budget and tough to keep fees ultra-low while you are trying to ramp up awareness. This is a challenge for all new entries not just ESG, but ESG has some specific issues that magnify the challenge.
What are the biggest challenges for ESG investing going forward?
Sonya Dreizler
ESG Consultant, Solutions with Sonya
I'm not an advisor, but I grew up in the Socially Responsible Investing space—my dad was one of the first advisor/planners to offer SRI, then I spent the first 13 years of my career in a BD/RIA hybrid with a presence in the SRI space. Now I consult to financial services firms on Impact, SRI, and ESG strategies.
I predict a few things: 1. Wider adoption of ESG data use by asset managers. How they use the data will vary widely but most firms will at least be reviewing or considering it during the investment process, because it's foolish to disregard material data. 2. More investors, advisors, and asset managers using screening technology to customize portfolios to values. 3. Traditional (not ESG focused) advisors will begin adopting more widely after losing next generation clients that want values aligned portfolios.
There are many surveys all asking similar questions in different ways. Data shows that most people (even baby boomers) are interested in learning more about sustainable investing. Interest numbers increase as age decreases.
Boston, New York, Portland, San Francisco, and Seattle are areas with a historical concentration of SRI professionals. So we see the most clients invested in SRI where there are advisors that have been talking about it. I suspect the same will happen for ESG.
I'm curious to see data on both ESG's affect on performance during a down market, and interest in ESG during a down market. (Though I'd prefer just not to see a downturn!) Another potential challenge could be issues with trying to "fit" ESG into a conventional model using only technology and not enough expert human oversight. Language around value-based investing can also be a huge stumbling block, especially for advisors getting comfortable talking to clients about ESG issues. With a little practice though, this may get easier quickly.
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Question 1
At the Paris Agreement in 2015, 195 countries agreed to limit dangerous climate change by limiting global warming to well below ...
A 1°C
B 2°C
C 3°C
Oops! Sorry that is the wrong answer!
The correct answer was...
While 2% is the upper limit, in fact the aim is to pursue efforts to limit the temperature increase even further to 1.5°C.
2°C
Go to next question...
Right On! That is the correct answer!
Question 2
According to the UN, how many years do we have to limit climate change catastrophe?
A 12 years
B 22 years
C 33 years
Hurrah! That is the correct answer!
According to the UN Intergovernmental Panel on Climate Change (IPCC), to stay at or below 1.5 centigrade will require cutting global greenhouse gas emissions to 45% below 2010 levels by the year 2030.
12 years
Question 3
The United States’ largest sector in terms of greenhouse gas emissions is ...
A Agriculture
B Electricity production
C Transportation
The key emissions from transportation stem from fossil fuels used in cars, trucks, ships, trains and planes. Over 90% of the fuel used for transportation is petroleum based.
Transportation
View result...
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To learn more about ESG topics and about how to combine financial returns with positive impact, please click here
Source: https://ec.europa.eu/clima/policies/international/negotiations/paris_en
Source: https://www.un.org/press/en/2019/ga12131.doc.htm
Source: https://www.epa.gov/ghgemissions/sources-greenhouse-gas-emissions
