This interview has been edited for length and clarity.
Welcome to another episode of “The Impact” on FinTech TV. I spoke to R. Paul Herman, who is an impact investment fund manager and grader of over 410,000 investments on climate, impact and ESG to pursue positive impact and profit potential and author of The HIP Investor.
Jeff Gitterman: Paul, welcome to the show. Talk to us about what you guys are doing over there. I know you graded over 400,000 stocks, bonds and issuers. How wide is the climate exposure and GHG emissions globally?
R. Paul Herman: Climate is a part of every company’s exposure. And so across 14,000 public equities globally and many of the bonds that they hold, it adds up to 80 billion tons of greenhouse gases. And so that’s something that includes not only what they produce, but how much energy they buy and all the emissions and pollution that the products give off.
So that’s the pollution that comes out of the back of a car or an SUV that you might drive, the pollution that comes out of the building from burning fossil fuels, and using energy around the world. So it’s a pretty dramatic exposure and of that 80 gigatons, more than 15 of that comes directly from oil, gas and energy. And that’s not even counting everything, because companies like Exxon and Chevron are not yet reporting their downstream emissions.
JG: So would this be considered Scope 1 and Scope 2 and Scope 3 emissions?
PH: It counts all three. Scope 1 Scope 2, Scope 3 for those that communicate and report their emissions.
But imagine if you had an income statement that didn’t report all your expenses or balance sheet that didn’t report all your liabilities. That’s what some large energy companies are doing today, and that’s what several companies around the world, across industrials, utilities, consumer discretionary. So this is the best estimate of what’s reported directly from companies on their greenhouse gas emissions and pollution.
JG: So now you’re tracking all these companies and hundreds of these firms already have science based targets. Or do GHG reduction. What goals are they committing to and by when?
PH: So this is really exciting. That 80 gigatons if you add up all of the emissions from companies with science-based targets. So there’s a poll of the thousand companies with science based targets and what that means is from some of the most aggressive, like Unilever, or Novo Nordisk, or Armstrong, which implements clean energy projects for governments. If you add all that up, that’s 16 gigatons out of the 80. So that’s the good news.
Unfortunately, all the fossil fuel energy is 15 gigatons. So these companies with science-based targets are seeking to reduce as aggressively as 100% by the year 2030. So it gives us another six years to get them at the average reduction from most companies, which comes out to about 5% a year or about a 20-year time frame just to achieve it.
JG: We know that there’s lots of goals out there. Can you tell by the work that you’re doing, Are we ahead? Are we behind on those commitments?
PH: Yeah, it’s a great question. And so it turns out there’s three categories of companies with science based targets for greenhouse gas production.
So the good news is about 350 companies or about half of the ones that have trackable targets. They’re ahead. They’re actually ahead by twice of their goal if you take a straight line reduction, so that’s the good.
Then there’s companies who are behind, and the interesting thing is they actually have some more aggressive targets, yet they’re only hitting half their goals. So the leaders are doubling their goals, the laggers are behind by half.
And then you have this category of about 150 global equities, which is about 20% of all the tons, they have aggressive targets, but unfortunately, they’re increasing emissions, so they’re not decreasing emissions. They’re increasing emissions despite having this commitment from companies like APTIV to reduce in the future, they’re actually increasing today. So they’re going to have to turn it around if they have any chance of it.
JG: It’s why on the show a lot, we talk about the addition economy because as much as we want to be in a transition economy it keeps looking like we’re in addition economy where we still keep adding a lot of new renewable energy, but also older, more toxic fossil fuel energy as well.
And and that’s why it gets me. It’s really my next question, which is we’re looking at all these climate threats because of the fact that we’re not reducing fast enough and I know PIP rates 14 climate threats and several forms of resilience. Which areas of the USA are most at risk from your viewpoint and which funds ETFs are incorporating these risks into their tracking?
PH: So this is really interesting. You know, we draw maps of the U.S., down to 3,100 counties across the U.S., and there is historical data over the past 40 years of what the weather impacts have been. And the big four weather impacts are heat, cold, wind and water. And those are things ranging from everything from flooding to the heat risks of some people going to the hospital.
What we find is that, I mean certainly further south in the U.S. as hotter, further north is generally cooler. And then the coasts of the U.S. have risks of flooding, hurricanes or, in the middle of the country, tornadoes. So all of us experience these weather risks and these increasing intensity weather risks, especially this summer.
What we are able to do is take that analysis down to the county level but also to 8,000 census tracts, 80,000 census blocks. It can even go down to 100 foot by 100 foot square block. And what we’re also able to do on this is to plot resilience and resilience can be anything from having a trees and forests like you have in Maine or Washington state, but lack of resilience can be in places like Florida, where the average altitude is 10 feet above sea level.
So what we do is we divide that risk by the resilience, of the land, of the community of the government policies, and what is not always intuitive is not only the states like Texas and Florida, light up on the map, it’s being right in the zone, including Mississippi, Alabama, Louisiana but also North Dakota, South Dakota, Nebraska. Because farmland isn’t as big a resilience, we need farmlands to grow food. But farmland itself is subject to erosion.
And then some places that, let’s say, depend on bee pollination, as those deteriorate, it’s going to threaten food systems. So there’s a lot of risk to address and capital markets are one way to do that.
JG: And of course, we’re seeing literally today plotting across the upper Midwest and the South Dakota region, Iowa. So we’re dealing with a lot of these problems that your fund is looking into for sure. It’s always interesting to me how you then make investment decisions.
PH: What’s both interesting and depressing and motive for action is that we’ve analyzed, as you called out, hundreds of thousands of muni bonds, and we’ve mapped them to their credit rates.
One of the visuals that we analyze this with plots that credit ratings from AAA, AA, A, investment grade, subinvestment grade against the hand climate threat resilience map. And what we find is that even in the AAA category states like Texas, states like Florida, which have a great credit rating at AAA, some cases you are going to have very high threat of climate and curation and very limited resilience. When you do that for all credit rating categories, AAA, AA, A, and you intersect that with the climate threats that are expected and the resilience or lack of resilience, we find basically a near zero correlation.
So credit ratings are not reflecting full risks of a 30-year bond. When you have a bond, is not just a two to three year cash flow, which frequently is the driver for the credit rating, you have 30 years of risk.
You’re trying to isolate against that, so this could mean that counties like Palm Beach County in Florida, which also houses Mar A Largo, are some of the riskiest areas for climate. And you combine that with Palm Beach County actually has a lot of waste dumps where the garbage from southern Florida gets put. And so if those are flooded, just like in North Carolina, if whole ash ponds are flooded that can contaminate the water supply.
So that’s pretty dramatic, whereas in the Northeast, in Vermont, New Hampshire, Maine and in the northwest, Idaho, Washington, Oregon, there’s more resilience including up in Minnesota, Wisconsin, because there’s both some muted risk, forestry to help mitigate, and limit wastewater flow, sewage overflows, and they’re taking action. They’re taking climate action in those areas.
JG: You know, you think you can rely, at least on the issuers, about the credit ratings to not take risk where it’s inappropriate. We know more and more bond issuers are starting to hire climate scientists and trying to look at these issues, so hopefully they can start to make measured choices about where they’re willing to take on risk and not take on risk.
We’re certainly seeing the insurers already start to make those decisions, so you would think that the issuers on the bond side would certainly be next. But what could investors do to be mindful of climate risk and resilience while optimizing their investment portfolios?
PH: So it’s really critical to evaluate future risk as an investor. That’s what we’ve done for our 18 years at HIP Investor is evaluate the future risks and the future upside from factors that derive from people and planet and trust. And the planet factors are super important because we can’t easily control them day to day.
These are accumulated trends over time of how we pollute the air and water and land, and so what investors should be mindful of is the in the case of corporate bonds or muni bonds, look at the full duration of the bond. To look at the ratings of the risk.
Not only the credit risk from the credit rating agencies, which sometimes don’t look at the full duration of all possible future risks, but we have HIP ratings of both the mission accomplishment of them and the climate threat resilience.
It’s meaningful as to where a hospital or a school as well as the city or a county is located and what action they’re taking. And so one of the things I think you just alluded to, Jeff, is that there’s things like green bonds which are now in the state of Florida. The governor Ron Desantis has said there will be no green bonds. He’s also now taking out … there will be no mention of climate change in law or policy or practice.
So as an investor, you have the choice as to what to invest in, whether to overweight or underweight, whether to include or exclude, and then what’s really exciting is cities and counties have climate action. Unfortunately, those climate action plans are, you know, underfunded by up to 90%, 95%. So funding infrastructure is certainly helpful, funding of things like infrastructure for sewage overflows in cities. We’ve written reports on that as to where to target or what infrastructure to bring in.
Understanding what renewable energy infrastructure is possible, how that can be decentralized, even though there’s a lot of improvements that we need to make to the grid how to connect the grid. So Texas is is only connected to itself. It’s not connected to the eastern electricity grid or the western electricity grid.
So lots of opportunities to manage your exposure to global equities, understanding news, taking action to prepare for ongoing climate change in your muni bond portfolio and in your corporate bond portfolio, even in your sovereign bond portfolio. These are all things that we track at HIP.
JG: So my favorite question to end with: First of all, thank you for all the work that you’ve been doing, but how do you remain hopeful and positive in the face of all this data that you’ve got to look at on a daily basis?
PH: Well, luckily my parents taught me how to be resilient and how to solve problems every day, and luckily I was born as an optimist and the Mayo Clinic has analyzed life expectancy for optimist versus pessimist, and they find that optimists outlive pessimists by 14 years.
And basically I’m driven by wanting to solve these problems. People across history have seen gaps in what we need to do and apply effort to do that, so I’m excited with your leadership, Jeff, the leadership of people in the audience, is that we all can solve this problem so we can adapt and evolve in there.
So that’s what drives me, and it probably also is driven by some of my upbringing with the Jesuit education and how to solve problems and to do so logically. So there’s a little bit of that built in to things we do every day to evaluate future risks, position for future upside, and to have strong resilient portfolios, maybe even fossil free portfolios for investors, for advisors, for fund managers, for 401(k)s.
And so we work with investors of all types to do that.
Watch the original episode here.
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