Speaker 1 00:00:24 Climate risks have been reflected across sectors and industries for some time now. And today, we're going to discuss recent research on how climate is priced into the market with shear vice president, head of thematic research at p gm, who will give us insights here. So how climate change, how is climate change being priced into the market, and what are the repercussions for investors? Let's start Sheia talking about research from a value versus values perspective. So from an enterprise value creation perspective as well as a moral perspective, what differences did you see when viewing these from different lenses?
Speaker 2 00:01:07 Well, it is such a pleasure to speak with you today, Kesa. Thank you so much for, for inviting me. Um, so as you mentioned, much, much has already been, been written about climate change for, for investors, and, and the bulk of it really appeals to the, to the moral imperative aspect of, of, of climate change. That is, um, it, it, it appeals to this notion that investors need to consider and act on climate change because it's the right thing to do now. Now, the moral imperative here is very, very clear. Climate change is impacting our planet, it's impacting human lives, and it's impacting our broad economy. This is, of course not, not debatable, and it will, it will continue. So even, even if I had a magic wand Kea and I was able to wave it wildly and halt all greenhouse gas emissions tomorrow, the, the current trajectory of climate change would continue for the next 20 years.
Speaker 2 00:02:00 Uh, the actions we take today will only impact the world after that time, but the moral imperative is not the only lens for investors to, to view climate change. And importantly, that that lens has not been very effective in spurring investors to take action. Uh, our research found that although roughly 90% of global investors recognize climate change is an important factor, almost 40% of them have yet to factor it into their investment process. So in response to, to this action gap, we deliberately chose to take a different perspective. Here at Kesa, we, we recognize that investors have a fiduciary responsibility, and in the US at least, the, the prevailing consensus is that consideration of, uh, of, of moral imperative is, is not always consistent with fiduciary standards. So for our paper, we thought it would be useful to set the moral imperative aside for the moment and examine climate change purely from a risk return perspective.
Speaker 2 00:03:07 Uh, and that is, that is essentially what what we've done. Interestingly, even though we took a very different approach, uh, we held climate change to a very different set of standards. We, we seem to have come out in a similar place that is investors really need to consider and act on climate change because it's impacting the macro economy, it's impacting markets, and it's impacting their investment portfolios today and will continue to do so. Bottom line, our research found that climate change is a material factor for all investors, whether they're looking to do good or do well, and it should be treated like any other critical factor for their portfolio, such as the level of interest rates or GDP or unemployment.
Speaker 1 00:03:53 So, excellent. I, I love what you're saying about climate change being really material, and I think clearly that's something that we as a marketplace and as a society, quite frankly, we're seeing more of that. And let me ask you, what catalysts might cause markets to reprice assets? So if we're really taking this seriously, what catalysts should investors be aware of when it comes to repricing, whether it's gradual or abrupt, um, repricing of assets, what sorts of things are important there?
Speaker 2 00:04:23 So, um, while, while climate change is, is, is readily, is readily apparent, you know, uh, a really key question for, for investors is, so how are markets handling this? And how well are they pricing it in? Um, and the short answer is of course not, not very well right now, uh, pricing it in, you know, markets are pricing climate in quite inconsistently, quite in completely. But what's critical for investors is that going forward, markets will price and climate change more, more fully. And as, as as, as you noted, our, our research shows, uh, this is much more likely to happen in stages and fits in spurts over time rather than all at once in an abrupt kind of one time repricing what, what, what, what some people refer to as a climate minsky moment. And one of the reasons we believe that that climate gets priced into markets, you know, over time, sequentially rather than abruptly, are the catalysts for this.
Speaker 2 00:05:22 Now, our report identified five catalysts working, working to drive markets to price and climate change more, I, I'd like to share two of them with, with, with you today. Uh, two that, that I think are especially overlooked. I think one is the collective nudges of consumers and investors, and the second is the data revolution that's, that's underway. So that, so that first one, you know, we often think government regulation and policy is the only way for markets to price in climate risk. And, you know, Europe certainly is the, is the poster child for that there, you know, uh, Europe, European governments have been at the vanguard of climate policy and they've really spurred pricing of, of, of, of climate risk throughout their economy, for example, in the utilities sector. But I would offer government regulation is not the only compelling force here. The, the United States government, by contrast, has been very hands off when it comes to climate policy, uh, especially over the last four or five years.
Speaker 2 00:06:25 But yet a number of US companies have responded with voluntary carbon neutral pledges, more data disclosures, you know, companies like Amazon Delta, Microsoft, Coca-Cola, Ford, Exxon, the list goes on and on. The, the largest US companies have made these pledges without any government mandates to do so. Which, which begs the question, why would they do that? What, what forces are they responding to? Our research shows they're responding to the collective nudges from consumers and investors, bottom line, when their clients, their shareholders, their bond holders want them to take action companies listen. But kesa probably the most important catalyst, the one that, that we're watching most closely, is the data revolution that's been underway in climate analytics over the last five years or so. Basically, new climate analytics are more accessible to investors. There are better quality and more granular than ever before. And the key point here is, is is pretty straightforward, better data leads to better investment decisions. And new data really enables investors to be smarter in their risk analysis and to, and to identify opportunities where, where maybe markets don't, don't do a great job of pricing in this risk.
Speaker 1 00:07:45 So I love that. So if we take your concept of the nudges, the response to consumers and investors that we're seeing, as well as the proliferation of climate analytics, how can we use those two to really understand investors' position on brown stocks versus green stocks? I think I might know an answer there, or especially when it comes to data and analytics, but what were your findings there?
Speaker 2 00:08:08 Let me, let me speak a a little bit more about the, about the data data revolution. You know, what I, what I mean by that is, is that there's, there's these climate analytics available today are of better quality. They're more accessible, as I noted, they're more granular than ever, ever before. But, um, you know, let, let me curb my enthusiasm here for, for a, for a moment. I do want to note the, the, the data is not perfect. There are still remaining gaps in, in reporting. There's plenty of room for, for improvement as far as standardization and uniformity of, of data. But the underlying trend I think is very, very clear kesa. And that is that climate data and analytics are much better today than they were five years ago, even three years ago. You know, we, we often think about climate change solely as a risk, but some of this alternative data that, that, uh, and these new climate analytics really shed light on hidden risks, but they also open up new avenues for investment possibilities.
Speaker 2 00:09:10 And, uh, you know, fossil fuel companies offer a really great example of the kind of opportunity that that can be uncovered here by, by leveraging some, some climate analytics, traditional ESG investment approaches, uh, take an exclusionary approach to to, to oil and gas companies. That is oil and gas companies have been banished altogether from, from portfolios of e sg investors for, for years, perhaps in part because it was not possible to differentiate between the firms in this sector. But kesa, what we're seeing from institutional investors around the world is increasingly they're looking for a more nuanced approach. They're looking to engage with some of these firms. There's a growing awareness that all firms in brown sectors can be, can be, um, you know, in inappropriately painted with the, with the same broad brush. And new climate analytics allow investors to differentiate between the firms in, in this sector to, to identify the greenest firms, let's say within the oil and gas sector, for example, you know, those, those firms that really embrace green technology and renewable energy sources and have made a, a firm commitment to a, to a lower, to a lower carbon future.
Speaker 2 00:10:25 And in differentiating between firms, like, like we're talking about, investors can outperform benchmarks because firms that embrace a green future, face less risk of extinction in a low-carbon world and are likely to outperform their, their, their more dinosaur peers. Also, by engaging with energy firms and encouraging their use of cleaner fuels, like natural gas over coal investors can influence the, the trajectory actually help reduce carbon emissions going, going forward. The, the the bottom line for, for investors is that embracing the data revolution, leveraging some of these new analytics can really allow savvy active investors to do good and to do well
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[email protected]. So let's talk a bit about some of the hidden risks that we see. So I know you mentioned some of the key areas that a lot of investors have been focused on in terms of using the analytics and using the data to really make distinctions there. Are there some hidden risks that we need to be aware of?
Speaker 2 00:12:25 I was listening to a, to a to a recent podcast of, of yours, uh, on, on fragility in, in supply chains. And you know, we, we touched on, on very much this, this same point in our research as as well. And supply chains are a prime example of hidden climate risk to companies. What do I mean by this? We don't often think of Swiss or Japanese pharmaceutical companies as being highly vulnerable to climate risk, but they are in their supply chains, which, which run through places like India, for example. You know, many pharmaceutical companies have manufacturing facilities in parts of India that are subject to extreme heat and water stress and manufacturing. Drugs and medicine can be a very water intensive process. And droughts and extreme heat spells can be very, very disruptive to the, to the, to the manufacturing of pharmaceuticals and medicines. What should investors do about this?
Speaker 2 00:13:20 Well, they can leverage alternative data and climate analytics to identify these risks and steer their portfolios away from them. So by alternative data, I mean satellite images, geolocation data of, of key manufacturing sites of say pharmaceutical companies in India. And, and, and by taking that, those, uh, those, those images and that data by, by overlaying this with climate metrics and I'm talking about extreme heat and water stress metrics, investors can identify which supply chains are most at risk and, and which, and which firms are most, are most vulnerable. We, we actually cover this exact example and others in our, in our research, and this is a real world example of how using climate analytics and alternative data can really help investors tilt their portfolios away from the most vulnerable areas and firms. Um, and if I can give a little teaser for our, for our paper, you know, big, big global pharma is, is not the only industry at, at, at risk either.
Speaker 1 00:14:25 Ah, such amazing information and tease away, um, regarding your paper and let us know how we can get ahold of it, obviously. And, and the last question, what are the top three issues investors should consider now around climate?
Speaker 2 00:14:38 As I, as I sit, sit here and, you know, think, think about the rest, rest of this, this, this year, there are, there are really three, three topics or three issues that that, that sort of come to mind when it, when it comes, comes to investors and climate change. First is climate policy in the us The second is climate change will absolutely be the kryptonite for passive investment approaches going forward. And the third is what, what can the pandemic teach us about climate change? So that first point, climate policy in the, in the us the Biden administration has, has made very, very clear their their objectives and priorities for, for climate policy. What remains unclear is how they plan to get there. Well, there should be some more clarity around this in the, in the next few, few months. And specifically, investors should pay attention to what policies and actions are passed through Congress and what gets signed into law.
Speaker 2 00:15:34 Because those, those policies, those actions will be the most enduring ones for the, for the future. Some areas that investors should be mindful of. It does not appear likely that, that there will be a carbon pricing mechanism in, in the United States nationally as, as, as there is in, in Europe. But it'll be interesting to see how much of President Biden's climate policy will be, will be policy carrot that is investment incentives, tax credits, and the like. And how much of his climate policy will be policies stick that is penalties, regulations, corporate mandates. In any case, the the, the details of policies going forward and how exactly they are, they're there to be carried out will be a source of risk and opportunity for, for investors. But let me be very, very clear about one really, really important point here. Kesa investors should absolutely watch to see what plays out with US climate policy, but they should not wait to take action.
Speaker 2 00:16:29 They absolutely need to move today to address climate in their, in their portfolios. You know, markets will be pricing this in more, more fully as as, as we spoke about regardless of government policy. Several other catalysts are already in motion. And, and that brings me to the, to the second key point for, for investors. As investors think about the best approach to integrate climate change into their, into their portfolios. I I wanna highlight one finding of our research that that really stood out very clearly. Pure passive index approaches which have gained in popularity immensely over the last few years are simply not equipped to handle climate change, either the risk or the opportunity. In fact, climate change could very well be the kryptonite for these passive approaches. Let me explain a little bit what I, what I mean by this. You know, certain aspects of of, of climate risk, the, the fact that its impact is non-linear, that it's so highly uneven across countries, even within countries, make it very, very difficult for passive index approaches to, to, to handle.
Speaker 2 00:17:33 It's, you know, these kind of irregular, non-linear risk are really the blind spot for index approaches that, that have underlying presumptions, that, you know, risks are uniformly and evenly distributed across an asset class. So pure passive approaches will stumble when it comes to climate risk, when it comes to investment opportunities arising from, from climate change. You know, passive approaches are likely to miss, to miss many of them as well. There's, there's no way for, for passive approaches, for example, to, to embrace alternative data, to, to use it to differentiate risk the way investors can. Now there's, there's no way for passive investors to take advantage of market mis mispricing. Either passive investors will, will miss out on many emerging opportunities as the world transitions to a, to a low carbon future. The key point here is, is that an active bottom-up approach that embraces new climate data analytics and integrates it directly into the investment process is the best way for investors to navigate climate change, really both the risks and the opportunities and the, and the third key point for, for investors for the, for the rest of 2021.
Speaker 2 00:18:41 You know, as we begin to emerge, um, at least here in, in the United States from the, from the limitations of the, of the pandemic over the past year, this is a really good time to reflect on our response to and our experience with, with Covid over the last year and what, what it could possibly teach us about how to consider, how to think about how to respond to climate change. And there are some, some clear parallels between, between covid and and climate here. First, their impact is universal. No corner of the world was, was was spared from covid and no corner will be spared, uh, from climate change as, as well either directly or indirectly. There's, there's nowhere to hide. And quite frankly, investors need to address climate change head on second parallel. The, the early part of last, last year, last January and February, you know, COVID was, was sort of on the, on the scene.
Speaker 2 00:19:37 It was in the news here, here in the United States, but it didn't really seem like a big deal until all of a sudden it was a huge deal. You know, both, both the pandemic and climate change are, are examples of, of non, non-linear growth that is both covid and climate grow exponentially and appear to be well contained one day and then are accelerating wildly out of control. The next bottom line, exponential growth, surprises, markets and investors. And the third parallel kisa for, for both covid and climate, there is a clear and pressing need to act early preemptively even, uh, if you, if you wait to see the effect, it's, it's already too late to act. Now, I'm, I'm hopeful that that, that all of us, not just investors can, can actually learn from, from our experience with the, with the pandemic this, this past year, and that we as a society will be, will be smarter in the, in the way that we prepare for and handle climate change in the, in the future. I, I know we can, we can do this.
Speaker 1 00:20:41 Such great insight. Sherry, I mean talking about the catalyst behind markets in terms of repricing assets, rather collective nudges of consumers and really understanding and responding to consumers and investors. Number one, in that second one, new climate analytics are just becoming more accessible. And also the top three issues you believe investors should consider around climate, US climate policy. You pointed to, we know what now the next question is how, how is it gonna get done? Climate change as kryptonite for passive investing. Um, very interesting phrasing there. And then third, the learning lessons that we're picking up. Obviously the pandemic being a top one and really, um, investors need to look at addressing climate issues today. Sharia, thank you so very much Sharia for your time. Thank
Speaker 2 00:21:27 You very, very much, Kisa. It was a, it was a pleasure. A lot of fun. Thanks a lot.
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