2020 Update on Climate Change

Yale’s investment policy regarding climate change asks that external managers:

Assess:

• the greenhouse gas (GHG) footprint of prospective investments

• the direct costs of the consequences of climate change on expected returns

• the financial costs of policies (such as a carbon tax) aimed at reducing GHG emissions on expected returns

Discuss with company managements:

• the financial risks of climate change

• the financial implications of prospective, well-crafted government policies to reduce GHG emissions

Encourage company managements:

• to mitigate financial risks and increase financial returns by reducing GHG emissions

Avoid:

• companies that refuse to acknowledge the social and financial costs of climate change and that fail to take economically sensible steps to reduce GHG emissions

Members of my staff speak with each manager about Yale’s policies and how they apply to the manager’s portfolio. This process communicates Yale’s position in a clear and consistent manner and gives Yale and the manager an opportunity to discuss the principles underpinning Yale’s policies. Investments Office staff regularly engage managers regarding the risks associated with climate change.

The Impact of Yale’s Approach

As I noted in 2016, when Investments Office staff first discussed my letter with Yale’s active investment managers, nearly all supported the approach described in the letter and appreciated the admonition to consider the economic impact of climate change on investments.  I am pleased to report that the response to Yale’s policy continues to be positive and confirms ongoing alignment between Yale and its external managers on how to think about the risks of climate change. 

Climate change risks regularly arise in the ordinary course of discussions between Yale staff and external managers.  For example, my colleagues have discussed with managers: the carbon footprint of various sources of power; the fuel efficiency of companies’ fleets; the energy efficiency of buildings that managers are developing, renovating or leasing up; and the impact of potential sea level rise on a developer’s land bank.  In a specific example, a manager contemplated making an investment in a services provider to the oil sands industry and reached out to discuss the potential investment because of my letter.  My colleagues reiterated Yale’s concerns about climate change risks and questioned whether this investment would make sense after taking into account climate change externalities.  The manager ultimately decided not to make the investment.   

Our managers take a variety of approaches to addressing climate change issues.  For example, managers have conducted environmental, social and governance (ESG) screens, employed state-of-the-art energy audits and developed their own carbon pricing analytics. [2]  They may go above and beyond common sustainability certifications, leading to less environmental impact.

One private equity manager conducts an ESG survey of each portfolio company at an early stage of acquisition to take inventory of material issues.  Together, the manager and the company come up with a way to measure ESG progress on a regular basis.  This process has resulted in numerous management-led initiatives with regard to carbon footprints of various companies, including avoiding packaging waste, deploying energy management systems and increasing recycling volume.   

A real estate manager developed a property that exceeds the standards set forth by the U.S. Green Building Council, resulting in 25% reduced energy use and 75% reduced water usage.  This was achieved through thoughtful design and construction, including electrochromatic glass that is programmed to adjust shading to the path of the sun and a rain water capture system; the manager also built a multi-layer water filtration system to clean polluted runoff from a nearby highly trafficked roadway, resulting in over 400,000 gallons per year of water flowing into the watershed that is clean enough to drink.

For many managers, Yale is often one of the more significant investment partners, placing the University in a strong position to influence a manager to incorporate the risks of climate change into investment decisions.  A typical reaction from a manager is that Yale’s policy is consistent with the firm’s values, but the manager appreciates Yale’s viewpoint and strives to be more explicit in the implementation of the University’s principles.  Following are a few quotes from our managers:

“The Yale letter on climate change continues to be a touchstone that we measure our actions against. Importantly, it has been a source of inspiration for our effort to deepen engagement with our portfolio companies. This has not only taken the form of tangible action, where we formally monitor the ESG issues that matter to our companies’ success, but also symbolic leadership, where, like the letter did for us, we can signal to our companies that environmental stewardship is a priority.”

“Shaped by our founder’s passion and concern for the environment, our company has a longstanding commitment to sustainability. Analyzing every possibility to reduce greenhouse gas emissions and to slow climate change while maximizing value for our investors remains at the forefront of our efforts. We remain focused on engaging with our employees, tenants, stakeholders and the communities in which we operate to advance our sustainability initiatives. To hear in clear and honest terms from Yale that we are all on the same page was liberating and inspirational, and energizes the efforts of our company to further our efforts.”

“Thank you so much for your letter detailing in a very thoughtful and sophisticated way Yale’s thinking on climate change and the ethical and investment implications that flow from it.  Since this is obviously an issue of deep importance to Yale and you were so gracious to ask for comments, on behalf of my colleagues, I am grateful for the opportunity to respond.  Having circulated your letter beforehand, we gathered this week for an all-hands discussion (we will have a follow-on meeting next week to agree and move ahead on the implementation details), and to the person, as individuals and investors, we support Yale’s policy 100%.  We believe Yale’s policy will help us invest better, that it will support us in serving the needs of a planet at risk from climate change AND driving higher returns for Yale and its educational mission.”

Even as the world transitions to clean energy (which it must), in the near term we will rely on some significant measure of fossil fuels; thus, how fossil fuel companies behave will make a difference. [3]  Yale’s external managers understand the need to minimize emissions in producing oil and gas.  It might be helpful to highlight one manager’s example.  Although we cannot describe in full detail the manager’s ESG processes, the manager is willing to let us share that it conducts a two-stage ESG pre-investment screening process, which includes GHG calculations.  Once a company is acquired, the manager trains and works closely with the company’s board on ESG issues, requiring quarterly reporting; furthermore, it is currently in the process of implementing GHG accounting in an effort to reduce each company’s carbon footprint.  Through a combination of operational improvements, electrification, wind power, carbon capture and storage, and advancing other technological solutions, this manager seeks to reduce the overall carbon intensity of its portfolio, which is already much lower than the world’s average for oil production.  This manager had the following to say to Yale: 

“The oil and gas industry must have two thoughts in mind – embracing the paramount energy transition, while at the same time producing oil and gas with the lowest possible emissions. For us, it is imperative that the companies we invest in are part of the solution and not part of the problem, as this will be their license to operate and futureproofs our investments.  Climate considerations are a prerequisite for both our selection of new investments and our work with the current portfolio.  In this, we believe we are aligned with the approach of Yale’s Investment Office.”

Yale’s Portfolio

The composition of Yale’s Endowment stems from many individual investment decisions made by a host of world-class external investment managers.  As these managers incorporate the full costs of climate change into investment choices and, in the cases of corporate investments, engage the managements of portfolio companies in discussions about addressing climate change, the risks associated with climate change are reduced.  The risk reduction may come from sales of offending investments, from avoiding offending investments or from influencing company managements to adopt climate-friendly policies.  The accumulation of investment decisions that incorporate the full costs of climate change leads to a shift in flows of capital towards less carbon-intensive investments and away from more carbon-intensive investments.

As I mentioned in 2016, at the time we articulated our policy, a few freely tradable investments in our portfolio were inconsistent with the principles of my letter, namely holdings in thermal coal miners and oil sands producers, two of the industries that would suffer if regulation imposed the social cost of carbon emissions on producers.  Working with our external investment managers, we successfully exited three of those positions, as I reported at the time.  Subsequently, we identified two other public holdings, which have been liquidated.

Private investments take much longer to exit than public investments.  Since 2016, one thermal coal investment held by a private partnership has been fully liquidated.  Although the process has been slower than we would have liked, the good news is that the remaining thermal coal private investments are on the way out of the portfolio. [4] 

Since 2014, Yale’s exposure to thermal coal and oil sands has declined from roughly 0.24% of the Endowment’s market value to roughly 0.02% of the Endowment’s market value today.

Conclusion

Yale’s investment approach to climate change contributes to the broader societal goal of transitioning to clean energy.  Under Yale’s approach, which asks managers to incorporate the costs of carbon emissions in investment decisions, investments with large greenhouse gas footprints are disadvantaged relative to investments with small greenhouse gas footprints.  When taking into account the full costs of climate change, investment capital flows towards less carbon-intensive businesses and away from more carbon-intensive businesses.   

Yale’s investment policy regarding climate change reduces portfolio risk and supports our fiduciary responsibility – to provide substantial, stable financial support for current and future scholars through the prudent management of Yale’s Endowment.  This support enables Yale to pursue its mission and to contribute to climate change solutions through its greatest areas of strength: research, scholarship and education.  I am grateful to the Yale community for its support and engagement on this important issue.

[1] In 2014, the Corporation Committee on Investor Responsibility (CCIR) adopted proxy voting guidelines regarding climate change.  In recent years Yale has held relatively few securities directly. When the University holds shares directly, Yale will vote for resolutions that support: disclosure of greenhouse gas emissions, analyses of the impact of climate change on business activities, strategies designed to reduce the long-term impact on the global climate, and sound and effective governmental policies on climate change.  

[2] All examples of manager behavior in this letter are shared with manager consent.

[3] For example, there is a wide range of carbon intensity for oil and gas production from various causes, such as gas flaring, methane leaks and venting.  Thus, there is a need for oil and gas companies to manage their carbon footprint with respect to their operations, which may have a material environmental impact.  At least one recent study suggests that the total petroleum well-to-refinery GHG emissions in 2015 are estimated to be ~1.7 Gt CO2 equivalent, or approximately 5% of total 2015 global fuel combustion CO2 emissions.  See Masnadi, Mohammed, et. al. “Global carbon intensity of crude oil production.”  Science, vol. 361, no. 6405, pp. 851-853, https://science.sciencemag.org/content/sci/361/6405/851.full.pdf.  Accessed 17 February 2020. 

[4] With respect to one firm that is no longer a manager in good standing with Yale, we took the unusual step of banding together with like-minded investors to vote against extending the terms of their partnerships in order to accelerate their liquidation of positions that do not meet Yale’s standards.  The majority of Yale’s non-compliant investments are held through these funds.