Industry Voice: How investors can manage climate risks and opportunities

clock • 4 min read

Given the investment being channelled into sustainable solutions, the corporate pledges to net zero and the greater awareness of climate-related risks, it is clear industry participants need to assess their priorities and align their objectives.

Morningstar's Lindsey Stewart, director, investment stewardship research for managers, and Vivian Frost, associate director, client relations for clients advisory, discuss the growing need for climate data.

What is driving the need for climate data?

Lindsay: We are seeing a variety of drivers for climate data from plenty of sources. We think that climate has really moved front of mind for a lot of investment clients recently after we've seen the big climate conferences like Cop26 and Cop27. Incoming regulation has really moved that to the forefront of clients' minds when they're thinking about what they're investing in. Additionally, we've seen regulation has started to pick up on that and we've seen climate considerations start to become embedded in plenty of new regulations that affect investment products. There are plenty of places from which the need for climate data for additional insight is coming and that's something that wealth managers are increasingly having to contend with when they're going out to their clients and pitching different products.

What are the building blocks for incorporating climate considerations into portfolios?

Vivian: When looking to incorporate climate considerations investors are looking to identify, quantify and manage those climate risks and opportunities. The first building block in that process is the carbon portfolio footprint assessment; understanding what the carbon emissions of a portfolio are. This provides the foundation to move forward and set reduction targets and to understand the point-in-time reference impacts of the portfolio.

The second building block is about transition risks. As the global economy moves to a low-carbon economy investors need those forward-looking assessments of how companies are going to achieve those decarbonisation plans. Morningstar Sustainalytics recently launched a low-carbon transition rating that provides a forward-looking science-based assessment of a company's alignment to that net zero pathway. It assesses both the emissions trajectory, the forward-looking emissions pathway against what we call a net zero budget, and then the company's actions in achieving that emissions reduction; looking in detail at not only the company's commitments and targets, but also the actions they are taking to decarbonize.

The third and final building block is understanding the physical risks of climate change to a portfolio. This can be done through an assessment of physical risks. Morningstar Sustainalytics has launched a physical carbon risk metrics data set that allows investors to understand the exposure to direct and indirect physical climate change impacts at the portfolio holding level.

What kind of conversations do wealth managers need to have with asset managers on the road to net zero?

Lindsay: The dialogue between wealth managers and asset managers is vitally important, but wealth managers need to go into those conversations armed with the knowledge they've gained from their other stakeholders, particularly their investment clients, on the key climate issues and sustainability themes. It's important to go out to investment clients and understand what their sustainability objectives and climate objectives are, if they have them, and even if they don't, because climate considerations are becoming more embedded in investment, they're going to need to think about what risks and opportunities those clients are facing. Once they're armed with that knowledge, they can better engage with asset managers to find out exactly which sustainability and particular climate objectives those managers are prepared to prioritise, how they are implementing that and how they are they integrating it throughout their business.

Increasingly we've seen the investment stewardship considerations - how asset managers are engaging with companies, how they voted at shareholder meetings, how they engage with public policy and regulation - are becoming an increasingly important part of the overall sustainability piece. Wealth managers will need to have get to grips with how asset managers are embedding those considerations as well, and what their investment clients are prepared to prioritise. It's becoming a more complicated piece and increasingly regulation is requiring those stewardship considerations as well, so there is plenty for asset managers to think about and for them to discuss with wealth managers in the future.