Investor Returns Trump Climate Denial

November 12th, 2018 | Ian Monroe

Climate change has already come for my family, and it is terrifying. Our small farm was leveled in the firestorms that devastated California last October. Twenty-two family members lost homes and nine of our neighbors lost their lives.

A year later we are still struggling to rebuild, the air again thick with smoke from a new wildfire next door, the Mendocino Complex, which has incinerated a record 1,661 square kilometers of forest and homes to become the largest fire in state history. In San Francisco, more than 200 kilometers south, the air quality is three times worse than Beijing.

With record storms, heat waves, and wildfires engulfing the globe, scientific models are becoming grim realities. I’ve worked on climate science and solutions at Stanford University for over a decade, and every year only strengthens the overwhelming scientific consensus that climate disruptions are already costing lives and livelihoods, with billions more are at risk. Yet the Trump Administration continues to deny basic science and roll back climate regulations at every opportunity in the US, while bold climate rhetoric from other countries hasn’t been matched with the economy-shifting scale needed to stabilize our planet.

What does this all mean for investors? Can climate investing benefit portfolio performance as the US runs backwards? It’s tempting to think that political ineptitude means business as usual, but where policy-makers are failing, investors are picking up some of the slack, motivated both by the urgency of our climate crisis and a more primal directive: higher profits.

In fact, climate-smart strategies are already yielding substantial outperformance. My team at Etho Capital incorporates climate metrics into diversified indexes and exchange traded funds (ETFs). By combining quantitative climate analysis and overall environmental, social, and governance (ESG) sustainability screening, our flagship ETHO ETF has substantially beaten S&P 500 since the fund launched in 2015. Our research has found the best results come from combining climate science and technology trends with several interrelated core principles which generally hold true, regardless of where the political winds blow.

Advantages from Climate Efficiency

Nearly every aspect of a company’s supply chain is connected to climate pollution, from agricultural and industrial processes that produce raw materials, to transportation for products and services, and electricity at company facilities. Because greenhouse gas (GHG) pollution is so pervasive, investors are finding that it can also serve as a powerful signal for overall supply chain efficiency, which in turn can identify companies that are better run, cost-effective, and positioned to outcompete their industry peers.

My Etho Capital team was among the first to discover how strongly company climate emissions can predict performance, publishing the effects of “climate efficiency” for a wide range of industries ahead of the launch of the efficiency-focused ETHO ETF. Independent research from Blackrock and Stanford University has since confirmed the financial benefits of climate efficiency (also known as “carbon efficiency” or “carbon intensity”). Intuitively it makes sense that getting more from less can yield big benefits, both for climate and the bottom line. Now data validates this intuition.

Supply Chain Data is Essential

For most companies, the biggest climate impacts don’t come from direct operations, they come from all the pollution connected to every input into a company’s supply chain, like materials, chemicals, or agricultural products. Collectively, these indirect supply chain emissions are known as “Scope 3” data in climate geek speak (contrasted with “Scope 1” pollution from a company’s direction emissions of greenhouse gas, and “Scope 2” emissions from electricity use).

Unfortunately, most companies still don’t report Scope 3 emissions, and climate focused-funds still often rely on self-reported data that stops on the factory floor. This makes for inaccurate accounting of both climate impacts and efficiency advantages, since uncounted supply chain emissions often total over 80% of the climate footprint of a typical consumer products company. Fortunately, it is now possible to model Scope 3 supply chain emissions for companies that don’t report, and our research found that these calculations are essential for optimizing the financial performance advantages from emissions data, particularly when constructing diversified portfolios that go beyond industries with high direct emissions, like airlines and utilities.

Cost-Saving Clean Energy

Full climate efficiency accounting in every industry is a factor of both smarter supply chains and cleaner energy use, and the cleanest energy is also becoming the cheapest. According to analysis from Lazard, unsubsidized electricity from wind and solar is now typically cheaper than power from fossil fuels, explaining the burst of companies declaring 100% renewable energy goals. Some companies, like Apple, are even pushing their suppliers to switch to renewables, cutting both supplier costs and climate pollution in the process.

Prepare for Climate Realities

Solving climate change will reshape many industries, leaving once booming businesses in the dustbin of history as cleaner options arise. Gasoline vehicles, coal mines, and natural gas turbines will soon go the way of whale oil and the horse and buggy. This isn’t just because the world needs to stop using all fossil fuels to make the math of the Paris Agreement come close to international targets, it’s because better (and soon cheaper) alternatives are already here. Bloomberg predicts that the combination of falling prices for renewables, batteries, and electric vehicles will push the price of oil into a terminal death spiral by 2025. Generous subsidies, car sharing services, fuel efficiency regulations, and full bans on internal combustion vehicles announced in Asia and Europe should only accelerate this transition.

Even aviation appears poised for electrification, with over 100 electric plane projects around the globe and both Boeing and Airbus announcing electric plane commercialization plans to satisfy mandates in Norway. Then there’s the food industry undergoing a quiet revolution of its own, with a combination of health, animal welfare, and environmental concerns driving diets away from red meat and dairy, which are responsible for more climate pollution than the entire transportation sector. American beef consumption has dropped by 19% since 2005, and healthier plant-based alternatives from startups like Impossible Foods and Beyond Meat are attracting substantial investor appetite.

There are also the risks posed by a more extreme and unpredictable climate, which is already disrupting supply chains and increasing volatility in commodity prices. Climate efficiency is a core tool for adaptation and resilience in this context, since the most efficiently run companies reap even greater competitive rewards when input prices rise for everyone. Climate efficiency also helps companies mitigate policy risks as governments ratchet up prices for carbon pollution, which ripple through global supply chains, regardless of whether or not a company lives in a regulated market.

Some companies have their own infrastructure especially exposed to climate chaos and liability, whether it’s from rising seas, violent storms, crop failures, or deadly fires. The wildfire that burned my home and killed my neighbours was started by sparks from power lines owned by Pacific Gas and Electric Company (PG&E), and state regulators have found the utility responsible for at least 11 other major fires in 2017. PG&E is now on the hook for an estimated $2.5 to $17 billion in damage liabilities from last year alone, and the company is warning of potential bankruptcy in a hotter and drier state filled with faster, bigger, and more deadly infernos.

ESG Integration to Reduce Risks while Avoiding Greenwashing

Of course companies face many risks beyond climate, and mission-driven investors care about a wide range of ESG issues. Smarter ESG screening can enhance investment returns further than climate efficiency alone, since ESG red flags can identify early warning for companies with bigger problems. We eliminate some industries entirely, like fossil fuels and tobacco, which we believe have no place in a happy and healthy society.

But the more interesting results come from where the ESG warning avoided a dramatic decline. We removed PG&E from portfolio consideration due to corporate negligence exposed by a deadly natural gas pipeline explosion in San Bruno, California, long before wildfire liabilities drove down share prices. Our ESG concerns around data and misinformation silos also removed Facebook ahead of the company’s record-setting $119 billion single day loss, and our cancer concerns eliminated Monsanto years before its liabilities starting dragging down Bayer.

The challenge with the most commonly used ESG datasets is that they are primarily based on what companies say about themselves through voluntary nonprofit memberships and corporate social responsibility (CSR) marketing. With sustainability ideals becoming mainstream, nearly every large company now claims to be green, and smaller companies without the staff to crank out glossy green reports can get penalized in conventional ESG rankings, even if their actual operations are more efficient. That’s why it’s critical to find data sources that are driven by external experts rather than self-reporting marketers.

Our standardized climate efficiency quantification has also helped us put companies of all sizes on an even playing field while avoiding corporate greenwashing, identifying leaders and laggards from a broader spectrum of industry competitors. Our 2014 analysis found Volkswagen had been one of the world’s least climate efficient automakers for nearly a decade, identifying the company as a lemon long before its devastating emissions cheating scandal hit headlines. This flew in the face of conventional ESG ranking wisdom at the time, with the Dow Jones Sustainability Index naming Volkswagen the world’s most sustainable automaker in 2015 for its exceptional gaming of the self-reported ESG system.

Maintain Broad Diversification

A common mistake that many climate-concerned funds and investors make is to bet the bank on a handful of cleantech companies, leaving them exposed to volatility from shifting policy and technology dynamics in very competitive industries. This sacrifices the benefits of broad diversification. In contrast, the ETHO ETF contains an equally weighted mix of nearly 300 companies of all sizes in a wide range of industries. Since no company makes up more than one percent of the underlying Etho Climate Leadership US Index, it doesn’t really matter if Apple or Tesla has a bad day. The index tends to move with the market, and we’ve seen substantial outperformance build over time. As much fun as it is to point out how smarter sustainability can help avoid big losers, what really sustains performance is broad diversification.

Putting It All Together

Climate change is the most complex collective action problem humanity has ever faced, and the full range of climate risks and opportunities will continue to evolve for investors. Of course, past performance can never guarantee future returns, but climate efficiency and ESG integration should only get more important in a world strained by resource challenges. Climate-smart investors are already gaining an edge. As investors act on better climate and ESG analysis the market will correct towards better companies, accelerating solutions in all sectors, and steering the world’s largest pools of capital in the right direction. The money will move because the returns demand it, and the returns will make climate a core element of fiduciary duty. Despite my family’s tragedy, I’m hopeful for what’s ahead.

The views and opinions expressed in this article are solely those of the authors and do not necessarily reflect the view or position of the Responsible Investment Association (RIA). The RIA does not endorse, recommend, or guarantee any of the claims made by the authors. This article is intended as general information and not investment advice. We recommend consulting with a qualified advisor or investment professional prior to making any investment or investment-related decision.


Ian Monroe

Etho Capital

Ian is Chief Investment Officer and Chief Executive Officer at Etho Capital, as well as a Lecturer at Stanford University. He is also the founding CEO of Oroeco, an award-winning web and mobile platform that rewards users for helping solve climate change. He is an Echoing Green Climate Fellow, an Institutional Investor Rising Star and one of TechRepublic's top 8 leaders in cleantech.