Julian Poulter

Under almost any climate mitigation scenario, investors in high carbon assets will one day awake to find that their portfolio has been hit by a rapid repricing in carbon liabilities. The only issue is when. The choice for asset owners of large systemic risks like sub-prime and climate change is to hedge, act early or wait for the crash. History shows that their fund managers are simply not geared to managing such risks and the carbon repricing period is set to leave many assets stranded and unable to achieve their return objectives.

To get asset owners to better balance their portfolios to account for climate risk requires that they re-analyse the way these risks are managed and what scenarios might destroy asset values. But all risk mitigation requires that they and their stakeholders already know where they stand, and currently this simply isn’t the case. This absence of data was the driver for the creation of the Asset Owners Disclosure Project (AODP) to gain transparency around how funds are currently tackling climate change in order to create a plan for change.

In 2012 AODP produced the first index of how large asset owners manage the most extreme of all environmental social and governance (ESG) issues, climate change. While the focus of AODP has always been pension funds, AODP has responded to requests from various civil society groups to include the world’s largest foundations in its transparency requests for 2013.

Many large foundations have spent a great deal of time and money on trying to solve key social and environmental issues, including climate change, but there has so far been little interest in how those programmes might be compromised by the very investments it makes from its core capital pool. Ethical investment has a volatile history of returns, so no one is suggesting that foundations necessarily adopt an ethical investment strategy and any perceived possible loss of return. But the real issue is about sustainability, not ethics, and about potential short-term sacrifice for longer-term stability. Many high carbon investments have been good return performers, so underweighting these in a portfolio may produce higher volatility in the portfolio. But the upside is relative protection from any kind of carbon crash.

Naturally, in the case of foundations, the reputational risk adds greater need to at least manage climate risk in a professional manner so as not to incur a double whammy of unnecessarily propagating the high carbon economy and risking their own capital.

The AODP methodology, underpinned by its survey, looks at core investment reasons for managing climate risk and the degree to which funds understand and tackle this risk-return balance. With 55 per cent of investments exposed to climate change and around 2 per cent in low carbon assets, the balance is systemically risky for asset owners in much the same way as sub-prime assets were in 2007. Those foundation CIOs and CEOs  who remember the 2008 crash and its impact on their core capital might do well to consider the seemingly inevitable phase of stranded high carbon investments, which will affect all portfolios significantly some time in the next 5-15 years. When an issue like climate change cuts across both grant programmes and investments, then it surely requires close examination, especially when leading asset owners in other areas are taking active strides to manage the risk.

AODP can help foundations to understand what is possible and what changes they might want across their fund to bring them into line with best practice. In the case of other asset owner classes like pension funds, the risk-return adjustment is reason enough to engage, but in the case of foundations actively trying to improve the fight against climate change, there appears to be a double benefit.

AODP issued its 2013 disclosure request to the world’s largest 30 foundations in June. This comprises 50 questions across five categories: transparency, risk management, investment chain alignment, active ownership and low carbon investment. It is available on the AODP website and any foundation with more than $1 billion can complete it for inclusion in the index. We are always willing to talk to foundations about the issue and why addressing the financial system is a prerequisite to solving climate change and world leaders such as CalPers, GEPF and others have publicly lauded the benefits of being involved.

Julian Poulter is executive director of the Asset Owners Disclosure Project