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CalSTRS CIO sounds alarm bells on climate risk; 'Investors need to wake up'

Highlights

One of the biggest U.S. public pension funds is considering more active investment strategies to account for worsening climate change risks.

The fund’s chief investment officer is "constantly surprised" by how many investors "bury their heads in the sand" when it comes to climate change.

Climate risk will be "the most dominant topic in the next decade."

Christopher Ailman is the outspoken chief investment officer of the California State Teachers' Retirement System, the second- largest U.S. pension fund with a $248 billion investment portfolio. CalSTRS is one of the major participants in Climate Action100+, an investor initiative pressing large corporate greenhouse gas emitters to take action on climate change.

Ailman spoke to S&P Global Market Intelligence about CalSTRS' focus in 2020. The following interview has been edited for length and clarity.

S&P Global Market Intelligence: I heard a really interesting quote from CalSTRS' director of sustainable investment and stewardship strategies during New York Sustainable Finance Week in December: "Past performance and track record is actually irrelevant now when it comes to choosing who's going in your portfolio."

How does that relate to your thinking about ESG and sustainable investing?

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CalSTRS Chief Investment Officer Christopher Ailman
Source: CalSTRS

Christopher Ailman: We've said for a long time that past performance is not indicative of future results. We have to recognize that the past has been primarily based on a hydrocarbon economy — to generate electricity, to move goods and services. The future is going to be other alternative energy sources. The future is not going to be a mirror of the past.

Did you hear anything during Sustainable Finance Week that surprised you?

Given the immediacy of climate change, I am constantly surprised at the slow reaction of the markets of institutional investors — the frank push-back I continue to get from chief investment officers, particularly out of the Midwest that just haven't begun to anticipate it or even think of it, that it will change how their portfolio is mixed and how industries are impacted.

CEOs are thinking about it. Insurance companies, frankly, are already pricing it in. Investors need to wake up and recognize this is a factor they've got to think about in their portfolio.

Who are these CIOs that are not taking climate change seriously?

I don't want to point fingers at my peers. But the middle of our country still is so energy-based and resistant to any kind of a dialogue about considering other factors and expanding their definition of risk.

I blame [the fact] that a lot of climate change [discussion] really started with a political perspective, which is very unfortunate because our country is so divided. So rather than intellectual discussion, it's viewed as a red or a blue issue.

The other problem in the Midwest is that so much of this has been discussed from just simply the divestment standpoint, which is a binary buy or sell decision. The reality of climate change is in everything, and it's everywhere. It will affect every facet of our portfolio. I can't emphasize that enough.

The primary exposure for us and everybody is in the utility sector. The world needs more and more and more electricity. And the slope of that line is shooting straight up when you think about India, China, Indonesia and their demand for electricity. We've got to find better ways to produce it and generate it and store it.

[Climate change] is going to be the most dominant topic in the next decade. You look at the history of our country, and we have done tremendous things, but only when we're faced with a crisis — then we really rally and react. We didn't start putting lifeboats on ships until the Titanic.

So I think, sadly, until something really slaps America in the face [we won't react]. And it probably, frankly, has to happen in New York, the media capital of the world. Hurricane Sandy wasn't enough to make people really step up and take notice and react and say, 'okay, we actually have to do something here.'

This very politicized environment you're describing sounds very difficult for CalSTRS and your peers to operate in. How are you dealing with that?

I'm describing a future where there's lots of opportunity, but lots of risks. So if you're an active investor, there's a chance of really outsized returns because this event is going to occur. We just don't know exactly when. We also don't know the exact severity. But that means for those that are nimble and can adapt there is tremendous return opportunity.

For those who don't, they're going to suffer from the risks and have lower returns.

Part of the challenge, though, is that a big fund like ours has tended to be passive and assume the markets will adjust and adapt to change over time. This change may be so disruptive and so rapid that it's one that my board has, frankly, honestly, [been] debating: Do we need to be a bit more active in anticipating those changes?

We're in the process of putting our plans together for what investing in a low-carbon future looks like for us and how we would adapt to it. Plans that incorporate that into their investments will find themselves ahead of the curve and outperforming versus plans that bury their heads in the sand and stay in legacy assets.