Green Linings: A Conversation on Climate Change
Jeremy Grantham says the pandemic taught investors to think more long term, while speaking with Morningstar's CEO Kunal Kapoor.
Editor's note: This article first appeared in the Q3 2021 issue of Morningstar magazine. Click here to subscribe.
Jeremy Grantham has long incorporated the impact of climate change and other environmental factors into his long-term investment outlook. At the 2018 Morningstar Investment Conference, he warned that we are in the “race of our lives” to mitigate the consequences of catastrophic climate change. Three years later, the co-founder of the investment-management firm GMO spoke with Morningstar CEO Kunal Kapoor for the 2021 Morningstar Investment Conference in Sydney. They discussed a wide range of issues, including the effects of the COVID-19 pandemic and asset-price valuations. But they mostly spoke about the environment and global warming and what the future may hold. Here, we focus on that aspect of their conversation, which took place in May. It has been edited for clarity and length.
Kunal Kapoor: As you think about the investment research business, what do you think are the long-lasting impacts of the past 18 months or so on the way people will do their work?
Jeremy Grantham: I’m hoping they’ll be a little longer-term-oriented, a little more interested in things that can go wrong and the black and gray swans that lurk offstage. I think COVID might have taught us that. We haven’t been learning that quickly with climate change, but I would say we are finally beginning to learn a little. And COVID is just a reminder—those kind of issues that are not your routine quarterly earnings type of issues are nevertheless much bigger deals in the long run.
I started pushing climate change 13 or 14 years ago, and I can tell you there was a lot of eye-rolling from our clients and from the general investment world. And time passed, and finally, you look back and you find that oil has gone from 15% of the S&P 500 to 3% and that whole new industries—wind, solar, energy efficiency, new agriculture—are everywhere. So, it creeps up on you in a very interesting way.
I think people are more willing to think about things like that now than they were a year ago. They were beginning to tilt toward climate change and longer-term issues perhaps a year before COVID. But this has really encouraged us to be a little longer term, which is brilliant to me, because that’s what I do. I quit portfolio management proper 15 years ago and spend my time only on the very big issues.
Plastics’ Not-So-Great Future
Kapoor: As you’ve been spending time thinking about the future, have you started forming kernels of new ideas that you want to explore further that have long-lasting implications? What might some of those be?
Grantham: We have a bee in our bonnet about toxicity. I think pesticides and plastics are doing a job on our health and the health of the insect world and the health of the whole natural world. Our sperm count has dropped, looking at the data, to a third of what it was the day I was born. That’s a hell of a drop. The first 80% of that drop didn’t matter. We were overengineered, like a good Victorian bridge. But finally, it’s whittling us down to a level where in the last 10 or 15 years, it’s begun to matter, and we’ve gone from almost nobody having trouble to about 15%—one in eight—young couples having trouble. And it’s progressing almost 2% a year, which is a sinister number, because that’s about the rate that the insect population is disappearing, and it’s showing no sign of slowing down.
That makes me feel that the plastics industry, the chemical industry, pesticide industry are all under potential threat from toxic losses.
Plastics are just getting warmed up. Plastics leach what they call forever chemicals into the water you drink and the food you eat—the wrappers around your food. These are a completely underestimated shock that will play out in the next 10 to 20 years—alongside climate change, of course, which is gathering speed as we sit.
Kapoor: You’ve been laying out the case for climate change and its effect on asset valuations for more than a few years now. At our conference three years ago, you made a very compelling case for why it could be bad news for companies that don’t start to pay attention to some of the risks and what it might mean for their operations in the long run.
One thing that has stood out for us, at least in the period since, is that a lot of investors have started to engage with companies and starting to talk about these issues more thoughtfully than was previously the case. But there’s also a school of thought that disavows engagement and believes that divestment is the better option when it comes to companies, particularly in sectors such as energy and mining. I’m interested in your perspective on whether engagement or divestment is the better strategy or whether they both have a role in how you think about them.
Grantham: I think engagement for the routine concerns is the way to go, and for many people, engagement is suitable. I think oil is somewhat the exception, because the oil industry ran a deliberate campaign of obfuscation, political propaganda to mislead the world. They funded dozens of organizations to put out basically fake news that it didn’t really matter—that climate change was a hoax, etc. The oil money was behind all of the above—and some coal money—when it comes to that. They’ve played a very big political role to confuse the issue on climate change. That should be criminal. I mean, it certainly has had a very damaging effect.
I think they did it very well. You might even say brilliantly. They’re very good, the merchants of doubt, as the tobacco guys were. Just as it cost 10 years of hundreds of thousands of deaths in tobacco, it’s cost the world perhaps as much as 10 years of progress on climate change action and government support and sensible regulation to move us in the right direction. This is absolutely a threat to our existence as a stable global society.
And we’re not willing yet, by any means—the year with the biggest increase in carbon dioxide, in the particles per million, was last year. We haven’t even started to decrease the rate of increase. It’s increasing faster than it ever has. This is 20 years into the battle, and it’s still accelerating, and everything that one reads about is accelerating: The rate of glaciers melting is accelerating. The rate of the ocean warming is accelerating. The last 30 years are three times the warming of the 30 years prior.
These are really alarming rates. The flooding has gone up very steadily in terms of numbers over the last 50 years. And simultaneously, forest fires. It’s not that there is less rain. In fact, there’s more rain. What there is are higher temperatures, so it evaporates the available water supply in parts of the world like Australia and the southwestern United States. It evaporates the water more quickly and leaves it more vulnerable to fires.
All these disasters are accelerating, and we’re simply not winning. So, we have to treat climate change as the mother and father of all exceptions. Really, we need a wartime-like effort to get behind it—at least a Manhattan Project. We need to put masses of money into research and development, into nuclear, too—into fusion research. Can’t afford to miss a trick. You don’t know, in the end, what may save our bacon.
I would engage with every situation that I could do, but with oil companies, I think they’re simply too cynical and too clever for engagement to count. Some of our universities said they would go for engagement, and I sit with bated breath to wait for their engagement program. We’ll get behind you, dear leading university. But nothing happens. When you get down to it, there have been very few special climate-change-type engagement programs.
For routine situations, though, voting greener, voting better is a very powerful tool, and BlackRock (BLK) and the boys en masse are moving at least steadily in that direction. Slower than I would have liked, a bit slower to start, but now they’re moving faster. And they are to be commended.
A Matter of Survival
Kapoor: What I also heard you say through those comments is in some ways, if you’re a fiduciary, it is also a matter of fiduciary risk, and getting behind these issues actually helps you fulfill your fiduciary duties. Yet I think you would agree that this is one of the hottest topics. There’s probably not a day that goes by when there isn’t something on The Wall Street Journal editorial page arguing that you’re ignoring your fiduciary risk if you do take ESG considerations into your analysis.
So, where do you fall on the argument around fiduciary risk and how fiduciaries should be thinking about this and talking about it with investment committees, with folks whose money they have been charged to take care of? How can that dialogue be a little bit more productive and a little less siloed than it is today?
Grantham: I suspect that E, S, and G are all going to be indicators of better management, and the ones that move quicker and position their firms will get more of the bright kids signing up, will have more customers in the end. I suspect it will be good for business. But that is not my area of expertise.
When I go to an ESG conference, I say, “Guys, S and G, they’re terrific. Some of my best friends are S and G. What’s not to like about good behavior?” But E is a matter of survival. And it’s clear that if you ignore E, you’re likely to wake up and find that the biggest industry loss of value in history is behind you, and you missed it.
And wasn’t that subtle, by the way? There was never a year where people came out and said, “The oil industry is collapsing—watch your tails.” By the way, in 1982, it was 23% of the S&P 500. But 10 years ago, it was 15%. And then irregularly—14%, 13%, 12%, 11%, 10%, all the way down to 3%—actually hit 2.5% for a while. That all happened without people pounding the drums that it’s going to happen. Yes, I was pounding the drum about climate change, and I was saying you should sell oil because it’s the right thing to do. But very few people predicted the biggest loss of value in the history of the S&P.
I presented it at your conference where wetook out each of the 10 big groups of the S&P permanently, and it hardly affected the return. Who knew the market was so efficient? Whether it was consumer durables or whether it was oil or whether it was utilities and so on, each major group missing since 1925 had only moved plus or minus 8 or 10 basis points around the average return. Quite remarkable. It seems the market may be gloriously inefficient in bubbles every 15 years, which we know it is, but it does a pretty darn good job in the long run of equating growth stocks with high-yield stocks and so on. There’s no easy free lunch to be had at the sector level.
Exceptionalism in VC
Kapoor: Jeremy, a lot of what you’ve been laying out makes sense if you are overseeing a large pool of money and you’re allocating assets and you have access to all kinds of information and data that allows you to make some of these decisions. I’m interested in hearing from you about what you think an effective framework might be for a financial advisor or an individual investor who’s starting to think about these issues and doesn’t have access to all the information and tools that someone like you may have, yet they are interested in starting to make a shift in their portfolios to reflect climate change and some of its effects. How can folks individually start to make a difference vis-à-vis waiting for the institutions they rely on to do that?
Grantham: Well, they can make a difference by buying climate change funds. I’m happy to say GMO has a pretty good one. ESG funds where many reputable firms have them—that would make a difference. It would be good if we had a better rating on all the funds’ voting records—how green they are—and it’s something the Grantham Foundation is working on.
Let me just say a word about our foundation, because we have a completely different investment approach. American capitalism it seems to me is past its prime, a little fat and happy, not aggressive enough. There’s only half the number of people working for firms one and two years old than there were in 1975, so we’re losing some of our dynamism.
But there is one thing where the U.S. is still exceptional, and that is venture capital. Venture capital is really attracting the best people these days. They don’t go to Goldman Sachs to write algorithms. They go into venture capital or to start a new firm. And they should. Venture capital is not like private equity or institutional investing. In the end, we have to admit we’re playing a cosmic poker game. We’re trying to beat the hell out of the other players, and it’s fun. But we’re not really creating net value. But venture capital is. We’re causing firms to exist that otherwise would not exist. We’re raising money for them. In some cases, some of us are giving good advice to them.
America does that very well, and we decided, in our foundation, to go for broke. We are aiming to put 70% of everything we have in early-stage VC, of which half will be in green early-stage VC. And we have our own team doing that—thoroughly exciting. Boston is a great place to do that. We started more new ventures last year than San Francisco. That’s five, by the way. It’s just amazing what new technologies are out there—microbes that will fix nitrogen in the ground and batteries that will last twice as long and weigh half as much and won’t burst into flames. The list is endless. And the challenge is endless. So, this is going to be where all the opportunities are.
The FAANG-type companies are what separate the U.S. stock market from the rest of the world—and not so much the P/E as the earnings. Most of the outperformance of the U.S. market in the last 10 years has come from extra earnings, and over 80% of that extra earnings have come from this handful of FAANGs. Now, they are recently sprung out of the venture capital industry. They are a classic demonstration of that pool of 20 to 50 years of venture capital—these are some of the winners that have become global giants, bone-crushing in their competence and their competitive spirit. I think that will continue and that it will be a true advantage for the American system.
Kapoor: I wanted to end it on a very specific note. I’m interested if you’d share a few books that have left an impression on you and ones you’d recommend that others consider as well for their reading.
Grantham: I’m afraid I’ve been very nerdy this year, because a lot of it has been on regenerative agriculture and green stuff, which is so exciting, but they would have everyone rolling their eyes in boredom, because they’re all quite technical.
But I’ve just started a biography on the American woman [Jennifer Doudna] who got the Nobel Prize in chemistry the year before last for gene splicing. She is involved in things that have terrific implications for agriculture and how you fight bugs without putting toxic chemicals on. You send a message courtesy of messenger RNA, like the vaccines, and it turns off the switch of the Colorado potato beetle, and it can’t process carbohydrates. We are investors in a firm that’s called GreenLight, in Boston. So, the Colorado beetle eats the potato and dies of starvation and falls to the floor of the field and is eaten harmlessly by the other insects. It changes everything. By the time we finish gene splicing, we’ll all have IQs of 150, and maybe we’ll be programmed to be long-term investors as well. No doubt we will have a value bias as a consequence.
 Isaacson, W. 2021. The Code Breaker: Jennifer Doudna, Gene Editing, and the Future of the Human Race. Simon & Schuster.
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