FRA: Hi. Welcome to FRA’s RoundTable Insight .. Today we have Max Horster. He’s the Managing Director and Head of ISS-Ethix Climate Solutions – a unit of Institutional Shareholder Services that enables investors to understand, measure and act upon the implications of climate change on investments. Max developed the industry’s leading methodology to gauge and assess climate impact on investment portfolios, resulting in the world’s largest database of company-level climate change data. He holds a Ph.D. in History from the University of Cambridge. Welcome, Max!
Max: Hi, Richard. Pleasure to meet you. Thank you.
FRA: Great. If you could start us with your background? How you got into this field? And your career?
Max: Sure. You mentioned that my focus used to be in history. After that, I ventured onto asset management. I worked for almost 5 years with a large global asset manager capital group and I was scared. I realized that a topic that’s really close to my heart is climate change which mattered to investors. With that thought in mind, I started a small company in Zurich, Switzerland and operated under the name South Pole Group. We were among the first to look into the topic of investments and climate change. That was 8 years ago. We were a little bit early. So at the time we started, the only investors interested in this topic was (1:49 inaudible). Mr. (1:51 inaudible) invested at the charge investor’s foundation or so – who wanted to understand whether the money that they invested is in line with their mission. But over the years, that changed dramatically and I think about 3 years or so, the topic has really brought mainstream investments. Mainstream investments come from entirely different angles which is from the risk perspective. So, not so much on how money helping (2:17 inaudible) but how the climate change affects the legislation and potentially affect returns. The market grew tremendously fast. As a leader of this market, we realize that, organically, we couldn’t keep up with the market growth. We were approached by quite a few organizations who were interested in acquiring us. So at some point, around the beginning of last year, beginning of 2017, we decided to enter a process. There was a handful of companies that were interested in acquiring us we’re gracious to be able to choose who we want to partner with and we decided to become a part of ISS (Institutional Shareholder Services Inc.) – which is probably known to this podcast as the largest provider of top government research and services proxy (3:23 inaudible). This is also one of the largest and certainly the fastest growing provider of ESG data (Enviroment Social Government data). Non-financial information. It’s the fastest growing in two ways – by organic growth and by acquisition (3:43 – 3:45 inaudible). Not the latest, I should say. Three weeks ago we added (3:48 – 3:52 inaudible) into our family as well. Since June 2017, we have been a part of ISS. We operate under the name of ISS-Ethix Climate Solutions. We basically do three things. We hep investors understand what climate change means for the investment and what the investments mean for the climate. We help measure (4:14 – 4:23 inaudible). Certainly, we help investors act upon that.
FRA: So, this is a fascinating topic area. Wondering what your thoughts are on climate change? Do you see global warming? Global cooling? Combination of the both? What industry’s sectors of the economy will be affected by climate change going forth?
Max: My view of climate change is impacted by the view of the scientific community on climate change. I’m not a climate fan myself. As you’re probably aware, the community of climate sciences is in agreement that … nobody is questioning that the climate is changing anymore I should say. There is still a bit of a debate of what the role of human being is in that – of mankind. Ninety-seven percent of climate fans say that man can play the role different degrees on this scientific event that is happening. Climate change is taking place. The community, policy makers and so on follow the scientific view that mankind is the reason for that – the reason for emitting greenhouse gases. The emittance of how we operate (6:05 inaudible) electricity. Therefore, in order to mimic the effects of climate change and reduce its effects and potentially combat climate change, we need to change as a world, as an economy, as a society. To the second part of the question, it is important to understand what the changes are that comes with climate change. To be clear, we differentiate between – we approach it from the risk perspective – we differentiate between transitional risk and predicted risk. Predictive risk is easily understood. When the climate changes, it can be warming and cooling, depending on what geography you’re at. The global climate is warming. However, there are some geographies where there is cooling because of its rippling effect. In general, when the climate is changing, certain physical effects happen – floods, drought but also heavy rainfall. Long-term changes also impact the economy. These physical effects are obviously impacting (7:58 – 8:02 inaudible). If you are producing fertilizers for southern Europe, due to climate change, agriculture won’t be possible any longer in the south of Europe. Your company might not be really affected by climate change but the market that you cater to is. It could affect the supply for your supply chain. We saw last year that the floods in Southeast Asia that the supply chain (8:30 -8:32 inaudible) were impacted by that. These are physical activity has affected every industry. Then, there are some transitional risks. Transitional risks are that come with the world closing in on climate change and trying to mitigate it. That is, of course, being done by regulators stepping in and saying we need to stop emitting CO2. This is triggered by society and changing the way they behave and the types of cars they drive and so on. This is what we call transitional risks and they’re heavily emit greenhouse gases and industries are impacted. That would be, for example, the oil and gas industry and the utility sector. At least the (9:27 inaudible) part of the utility sector, the energy sector in general. In these industry sectors, you have to differentiate between industries where they have to substitute technology that is kind of climate adjustable and where it isn’t. So, if you think about (9:48 – 9:50 inaudible) produce cars that are emitting less or no greenhouse gas emissions – electric vehicles substitute technologies for the combustion engine. You can also produce electricity through other (10:05 – 10:12 inaudible). Water, wind and solar. There are substitute technologies that means a company (10:20 – 10:21 inaudible) in a specific sector. The company can transition. There are also sectors that cannot transition – the oil company. An oil company is an oil company. If it doesn’t produce oil any longer, it falls into a different sector. This is how they approach looking at different sectors and what affects climate change legislation on one end and the climate change effect on the other end and how they affect those sectors.
FRA: Does your firm, ISS, advice clients on climate change issues relating to ESG-CSR (Corporate Social Responsibility)?
Max: Yes. This is the core of what my group and I are doing. We advise and we provide data and screenings that help investors frame the topic of climate change. Then measure where they stand. These are risks that I mentioned; physical and transitional risks. First we would look at what the frame of the topic means. We help organisations that are sometimes very large asset managers or asset owners to understand what the topic of climate change for them and for their specific DNA. To give an example; If you are a government pension plan of the country that is heavily dependent on oil exportation, you might take a very different view on the topic of climate change than a church (?) investor. Or you might take a very different view than an insurance company that not only (12:01 – 12:03 inaudible) but also on the liability side that therefore affects the climate change. So framing the topic is the first step that we help investors with. We come in with our consultants and we help determine what climate change means and creating policies around it. Then, in the second step, we help measure where the client/investor stands. That is typically done by providing the investor with data. We can provide raw data because the investor has the capacity to run themselves where the big risks are and where the opportunities are or where the impact lies. More often the case, especially when an investor stops looking at this topic, they send us their portfolios and we run the analysis on their behalf. There, we create either (13:04 – 13:06) depending on who the stakeholder is and what the aim is. We create reports that point out, almost like a heat seeker, where the risks and where the opportunities are. We also suggest steps that the investors can take to address those.
FRA: In terms of all the actual tools and methodologies, what are those that the ISS use to assess the investment implications of investment asset classes in firms?
Max: Typically, what investors start with is called the investor’s carbon footprint. The logic is that you own, let’s say an equity portfolio, you own 0.1% of general electric. The investor’s carbon footprint allocates 0.1% of GE (Greenhouse Gas Emissions) to your portfolio to you first. Then you can do that for other companies and you can calculate your emission exposure. You can understand what your expose is to what amount of CO2. How many tons of CO2 does the company that I own emit? (14:25 – 14:28 inaudible) that against benchmarks. We understand whether you are you below the benchmark or not. The benchmark could also be your own portfolio two years ago (14:36 – 14:39 inaudible). That’s the very first step that an investor takes and is typically a very good one to start with. It has some limitations but it quantifies the topic of climate change that investors can process very well which are numbers. Tons of C02. CO2 in many geographies has a price. You can associate the price with us and you can convert tons of CO2 into, for example, basis points. You can say that the direct costs of greenhouse gas emissions that your investors are responsible for is equivalent to is half a basis point. That is a language that is understood and trusted across an organization. From then on, we analyze, what I mentioned before, the transition risks. These can be risks that can be very sector specific. We would tell you what other companies you are invested in. Let’s say in the oil and gas energy sector have exposure to (15:41 inaudible) or to arctic drilling or other practical steps in the transitioning world might face the risk of being reduced by the regulator block by the regulators. We look at physical risks. So, one of the physical risk exposure achieved in long-term off the company portfolio – when we look at what we would call “scenario analysis”, you might be aware that the world committed in the Paris Agreement to limit global climate change to well below 2 degrees. Keep in mind that we’re geared toward 6 degrees of global warming. So, if we really stick to this 2 degrees’ target which every country in the world signed, and those countries ratified, that means a lot of countries have to change. If we look at what companies in your portfolio can be 2 degree aligned in the future. Will we still have such a business model in such a world that we committed to transition to.
FRA: Through this work that you have been, how are investment asset classes affected by climate change overall? What have you seen?
Max: I would differentiate between liquid and non-liquid asset classes. The most important differentiation in our business world is to see why. Because when it comes to physical risks, we’re physically affected by climate change. The increase of floods, droughts, storms and so on and these risks are ten to fifteen years out. They increase over time, but in the liquid asset class, you’ve caused (17:33 inaudible) out of them. I would say physical risks – or let’s say liquid asset classes are very much focused on the transition risk. With the equity portfolio, you are concerned about a government committing to a (17:50 inaudible) tomorrow because at that moment, you might own a company that is larger and the (17:57 inaudible) might tip the share price. You’re not so concerned about the curious perspective but about the physical effect of climate change in ten to fifteen years because at that time, you might not own that company any longer. When you think about non-liquid asset classes, namely real estate and private equity. It’s an entirely different ball game. We see today that in these non-liquid asset classes that physical risks are being taken into consideration in the moment of the investment. In other words, if you build a hotel on the shores of Florida and you realize that the hurricanes are increasing in magnitude in terms of strength and number, that matters to you much more as that what it will look like in ten to fifteen years – how climate change impacts these storms. This is much more for you and for insurance companies on selling you insurance for that hotel.
FRA: Has the impact to the bottom line then – impact on profitability positive or negative? What classes or firms could be affected by this in terms of profitability? Positive or negative?
Max: It’s an interesting point. There’s a lot of studies being done on that right now and the question whether the risk of climate change is prized into company valuation already today. You do find a lot of studies that support this view – that companies that have the risks and opportunities that climate change are better under control than others; if you create a basket of them and run them against others’ index, there are studies out there that states that these companies are outperforming their peers. That is also a reason for increasing the amount for low carbon investments strategies that are currently being created or have been created the past few years where asset managers put together portfolios with such promise and (20:26 – 20:29 inaudible) – so that an outperformance is possible.
FRA: Very interesting. Do you know of any indexes like passive index or smart beta index that currently exists that focuses on firms with a view focusing on climate change?
Max: Yeah. I would almost turn it around. There is hardly any major index out there that doesn’t have some sort of a climate adjusted index summary. I would say they are at very different levels when it comes to education. The most basic ones are typically indices that either excludes fossil fuel companies – what I would refer to as a divestment approach and would resemble a reference universe without the oil, coal and gas companies – or take out or reduce exposure to companies that have a larger carbon footprint. They basically emit more emissions than their peers for the same output. They are less carbon efficient. This is kind of the first generation of indices and there you find (21:50 – 22:00 inaudible). What I am excited about are (22:06 – 22:07 inaudible) indices that are most sophisticated and try to investment in companies. For example, only companies that have a 2 degree targets and are committed to it. So, companies that are ready to say we are committed to the transition to be in alignment with the climate goal. There a lot of companies out there across all sectors. You invest only in companies with a climate strategy and don’t invest in those that don’t.
FRA: Interesting. How do institutional investors invest in climate change today and how can retail investors look to investing in climate change?
Max: I would say that institutional investors, depending on what you’re looking at, the large asset owners in Europe have all started to look into the topic of climate change and the flagship asset owners in the U.S. have as well. The same goes for Australia and Japan. The way that they approach is that they first want to figure out where they stand. So they do kind of a status quo assessment of what is my first climate change today? And then they typically set themselves some sort of either a pathway so they have a climate strategy. Now, more often than not, their strategies might include targets. Their target could be: we commit to bring down the carbon intensity of our portfolio by 20% by 2020 or we want to bring up the companies that have a climate strategy in our portfolio. Another element that would be involved in the ISS would be the topic of (24:10 – 24:13 inaudible). In North America, the number of shareholders on the topic of climate change were at an all time high last year with 89 shareholders that addresses the topic of climate change. This year, now it is April 2018, we are already at the same amount. We expect that this number would be much higher this year and these are the shareholders that ask companies to close greenhouse gas emissions or to get themselves a 2-degree target. These shareholders are increasing its effect by institutional investors who often drive those in some sort of a collective engagement initiative. (25:00 -25:05) New York, California and so on as well. They are getting involved and then they look for products that help them to manage their greenhouse gas emissions or climate impact in general to manage that bound. That’s also a reason why we see increasing investment products popping up in that space. Retail investors, it is a bit of a different story but there are now online platforms available for retail investors where they can basically go online and type in the name of a fund that is available for retail investing and see how the climates affects us. One that we have been building on behalf of the European Union is called Climatrix. Climate Tricks minus waiting.org (I cant find the website). That is a platform where you can look every after 5000 largest retail funds that are registered for sale so it includes some U.S. funds as well and check them for the climate affects. Free of charge. You just go on there and you type in the name of the fund and it tells you whether the fund has one to five (26:36 – 26:40 inaudible) data points that is something easier to digest which is kind of a leaf system. So five leaves is obviously better than four. That is something that retail investors can do invest there and they can, of course, walk into their bank and talk to their advisors and ask for climate adjusted investment product. There is an increasing amount available.
FRA: Wow! That is interesting. Finally, where can investors find more information on climate change investing and also learn more about your work?
Max: We produce quite a bit of research as you can probably tell. You can find it at ISSgovernance.com. Where you then can look for climate solutions and mail us or reach us. Other resources that I find useful are thinktanks. There are two in particular that deals with investors about climate change. One is carbon trekker and the other one is called the two-degree investment initiative. Great resources, especially for methodology. Great way to read up on different approaches to investment in climate change.
FRA: Great insight on the whole industry here and investing in climate change, Max! Thank you very much for coming onto the program show.
Max: Thank you for having me!
By: Karl De La Cruz