Making the Impossible Possible

“The Impossible Possible” was the name for the legendary Harry Houdini’s great escape artist show, where he faced seemingly insurmountable barriers yet always found a way to break free from the chains, straightjackets, and other devices that kept him constrained.

The coronavirus pandemic has forced us to stay home and get off the roads, and the recent photos of the blue, smog-free skies over Los Angeles are an example of an impossible possible for the smoggiest city in the United States. They are also a vivid reminder that the seemingly small things each of us do every day add up to a huge impact on the environment.

That's why Morningstar is joining thousands of other businesses around the world in celebrating Earth Day by offering a series of articles, research, and insights for investors. This year's Earth Day theme is climate action, making it a perfect time to evaluate if your investment portfolio is climate-aligned.

Why Should Investors Care About Climate Action Now? One reason this issue matters is that investing is about managing risk.

Putting aside any personal values or political beliefs about climate change, it’s important to recognize that scientists and economists agree that a changing climate will have rising mortality rates and big changes in labor supply, energy demand, and agricultural production. The recent pandemic shows how a global systemic risk can cause a dramatic market downturn. And governments and economies are ill-prepared to face the fact that climate change is indeed a global systemic risk.

Costs are already starting to increase from record temperatures and more-frequent severe weather events linked to a changing climate. Floods in 2019 across the Midwestern United States cost $6.2 billion in damages. Droughts in Europe in 2018 disrupted shipping on the Rhine River and curtailed production at the world's largest chemical company. Climate risk is an investment risk.

How Will Climate-Aligned Portfolios Fare in the Long Term? Morningstar equity research on environmental, social, and governance factors shows that companies that effectively manage their social and environmental risks, like climate, tend to outperform and build profitability for the long term. During the recent market downturn, Morningstar research also showed that sustainable funds weathered the sell-off better than conventional peers.

One reason for this is that sustainable funds have less exposure to energy stocks, which fell more than other sectors. A bigger reason is that companies in these funds generally have better ESG credentials and are better at spotting and managing environmental and social risks.

Long-term investors also should be thinking about how their portfolios will perform in tomorrow's economy. The transition to tomorrow's low-carbon economy will take decades, but it's already underway. Consider:

• The transportation sector forecasts that electric vehicles will grow from 3 million today to 125 million by 2030.
• The agriculture sector is introducing new innovative technologies to increase crop yields in water-scarce areas.
• Renewable energy now makes up 26% of global electricity generation.
• The building sector has gone from 5% green-certified new construction in 2005 to 38% today.

By taking the temperature of a portfolio to see how it is climate-aligned, investors also gain a window into their long-term risk and opportunity.

Inertia favors business as usual and often makes it feel impossible to avoid climate risk. This Earth Day, Morningstar joins with others around the world to take climate action, make the impossible possible, and reduce investors' risks from climate change. And we're already taking steps. We've announced plans to acquire Sustainalytics, a leading global provider of ESG data, to help all stakeholders in the financial markets--investors, institutions, and financial professionals--be part of the climate solution.