Robert Fernandez on how climate change can be a risk multiplier

Robert Fernandez of Breckinridge Capital Advisors talks to Climate Action about how climate change can be a risk multiplier, magnifying the existing credit weaknesses of an issuer. Investors should take note of how issuers are addressing material risks to their businesses and mitigating against climate.

What is the importance of our issuer engagement efforts?

Breckinridge believes that thorough credit analysis requires an evaluation of both fundamental financial information and environmental, social and governance (ESG) considerations. Our ESG assessment includes an ongoing engagement program with corporate and municipal bond issuers.  Engagement is important to Breckinridge’s research process in the following three ways:

• The direct conversations help us paint a fuller picture of the ESG profile and performance of the bond issuer. They offer insights into the key ESG drivers for the sector and the information shared during a conversation can supplement what is disclosed in a company’s sustainability report.
• Second, we take advantage of the engagement discussions to emphasize our commitment to ESG analysis. We demonstrate to companies as well as municipal bond issuers that ESG analysis is a useful and valuable form of investment research. On several occasions, company representatives have asked us to share our perspective as an ESG-integrated investor. As a result, dialogues have been constructive and mutually beneficial.    
• Finally, Breckinridge believes that collaborations with other investors offer an effective way to engage with companies on material ESG topics. As an example of a valuable partnership, we actively participate in the Climate Action 100+ initiative, urging three US-based companies to address their climate risks. 

Why is climate risk a material ESG factor for bond issuers?

Climate change and its consequences—extreme weather including hurricanes, typhoons, cyclones, and tornadoes; rising seas; melting ice caps; wildfires; deadly urban heat; coastal flooding; persistent droughts—are constant threats to human life and commerce.

On August 7, 2021, the UN Intergovernmental Panel on Climate Change (IPCC) assessment report stated that climate change is unequivocally driven by greenhouse-gas (GHG) emissions caused by human activity. More than 200 scientists convened by the UN to develop the report concluded that nations can no longer stop global warming from intensifying over the next 30 years.

We view climate change as a risk multiplier in the sense that climate events can magnify the existing credit weaknesses of an issuer.

Municipal issuers are ground zero for physical climate change risk and the challenges vary based on their location.  A coastal city will need to adapt to rising sea levels while a water or electric system situated in an arid part of the US will have to contend with more persistent droughts.

In addition to physical risks, certain companies Breckinridge invests in are facing acute climate transition risks. Companies in carbon intensive sectors such as utilities, mining and oil and gas must confront the global shift to a low or no-carbon future.

Our engagement discussions in 2021 highlighted the dimensionality of climate change. Climate change is a pervasive risk across corporate and municipal sectors. During their daily team collaborations as well as in their engagement meetings, our analysts observe, discuss, and share how climate change risks—in all of their dimensions—often are common to multiple sectors as well.

We believe that the businesses and municipal operations that best plan for, mitigate, and adapt to the risks of climate change will be the most sustainable.

What do we see as next steps in addressing climate risk?

Our engagement discussions highlight where climate related action demands attention. We spoke with both corporate and municipal bond issuers that are leaders in pursuing initiatives to manage physical and transition climate risks. However, it is also evident that many issuers are in the early stages of mitigating or adapting to the effects of climate change. Many could take the first steps on their own. For example, companies and local governments could explore collaborative initiatives with other issuers in their sectors or regions and third-party academic and advocacy organizations that already are conducting programs to address climate adaptation, mitigation, and resiliency.

From an investor perspective, we believe improved climate risk disclosure by both companies and municipalities is an imperative. For investors to gain access to the information they need to make sound investment choices, government regulators must provide additional disclosure guidance on climate risk. We are encouraged that the SEC has been actively working on this. In addition, sustainability related nongovernment organizations (NGOs), such as SASB, CDP, and TCFD, serve an important role in the reporting ecosystem, through their advocacy and by creating voluntary disclosure standards. We endorse efforts to bring about better climate reporting. Although climate reporting from corporate and municipal issuers has improved, lack of transparency about climate risks across the capital markets remains a challenge. We want issuers to commit to meeting higher disclosure practices. Improvements in this area will also allow bond issuers to better manage their risks and showcase their progress to investors and other stakeholders.

Two conclusions are inescapable when it comes to climate change: 1) our current business and social models cannot be sustained in the absence of a commitment to addressing material risks, and 2) investors must have reliable, actionable information that they consider as they decide where to direct their capital for investments oriented to long-term sustainable performance in the markets and society.

 Why should institutional investors care about climate risk? Why should climate be on the Investment Committee agenda?

This can be answered from both asset manager and asset owner perspectives.

Asset owners possess investment portfolios that are generally managed with long- or perpetual-time horizons. In their governance role, investment committees are responsible for the stewardship of these assets.  The committees work with their outside consultants and managers to build an asset allocation mix that generates a return sufficient to meet investment goals and financial obligations. It is increasingly apparent that climate change will affect those expected returns. As a result, asset owners are increasingly incorporating climate risks into their investment policy statements, given both the short and long-term risks of climate change and their potential impact on security prices. 

As mentioned above, as an asset manager, Breckinridge believes that the most sustainable businesses and municipal operations will be those that best plan for, mitigate, and adapt to climate change risk. The consequences of climate change are increasing and threaten many aspects of our life and our economy. Investors should pay attention to how issuers are addressing these material risks to their business and how they are adapting to mitigate those risks. Particularly for an investment grade fixed income allocation, capital preservation, principal protection, and a long-term view are very important. If left unaddressed, climate risks could have a negative impact on investment returns.

DISCLAIMER:  This material provides general and/or educational information and should not be construed as a solicitation or offer of Breckinridge services or products or as legal, tax or investment advice. The content is current as of the time of writing or as designated within the material. All information, including the opinions and views of Breckinridge, is subject to change without notice. No assurances can be made that any estimates, target or projection will be accurate or prove to be profitable; actual results may differ substantially.

While Breckinridge believes the assessment of ESG criteria can improve overall credit risk analysis, there is no guarantee that integrating ESG analysis will improve risk-adjusted returns, lower portfolio volatility over any specific time period, or outperform the broader fixed income market or other strategies that do not utilize ESG criteria when selecting investments. All investments involve risks, including loss of principal.

Some information has been taken directly from unaffiliated third-party sources. Breckinridge believes such information is reliable but does not guarantee its accuracy or completeness.

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Breckinridge Capital Advisors will be speaking at the Sustainable Investment Forum North America during Climate Week NYC and you can join them by registering here today.