Every day shows more alarming evidence of global warming, including catastrophic flooding in Spain, devastating back-to-back hurricanes, wildfires in the Amazon and elsewhere, and extreme downpours in India. The list goes on. It’s why the United Nations meets annually to make progress on curbing climate change. For investors, there are plenty of risks and opportunities associated with the carbon transition.

Donald Trump’s victory in the US presidential election suggests that efforts to curb global warming may slow down in the US. In his last term, the former president withdrew the US from the Paris Agreement to mitigate climate change. We checked in with Jeff Gitterman, a financial advisor with a specialty in sustainable investing, about how he builds a climate-friendly portfolio, both before and after the US election. Following are the edited excerpts from our conversation.

Leslie Norton: Before we get to the election, let’s spell out what the warming world means for investors. We’ve blown through our deadlines to curb global warming.

Jeff Gitterman: On the equity side, the typical investor time horizon is one to three years, and investors aren’t really willing to take into consideration much longer-term risks. There are some longer-term risks on the bond side, which does change the risk profile. The risks when holding debt can extend to 30 years. When someone takes out a mortgage, they start to think about the value of the home over the next 10 to 15 years. The same is true for municipal bonds and infrastructure debt. Climate risk starts to look much more meaningful when you’re holding debt for a long time.

For the past 10 years, our premise has been that carbon transition risk is, unfortunately, not a major risk to investors. We coined the term “addition economy.” We’ve predicted for a while that we would be adding to our energy mix and not reducing fossil fuels. We don’t see anything on the horizon that changes that, especially now that the BRICS (an organization that includes Brazil, Russia, India, China, South Africa, Iran, Egypt, Ethiopia, and the United Arab Emirates) are setting up their own NATO-type alliance.

Norton: What are the biggest risks?

Gitterman: Physical risk. And the hydrological cycle. There’ll be more water in some areas and not enough water in others. Warmer air holds more moisture. Our theme has been that we need more energy, which means more warming, and thus more risk in the hydrological cycle. That means, in the future, we can’t rely on what we’ve built our society on in the past. It doesn’t mean we can make accurate predictions about where disasters will occur. This makes climate investing very challenging. I don’t think anyone predicted North Carolina would be the center of the worst water damage since Hurricane Katrina.

Norton: Where are the opportunities?

Gitterman: From an investing standpoint, we have to think about broad trends as an investment opportunity and broad trends from a defensive position. From an investment opportunity standpoint, we think about three direct investment trends. The first is sustainable infrastructure, which overlaps a lot with grid infrastructure, or investments into the direct electricity grid. Artificial intelligence pours fuel on the fire of climate change because of the energy demand. We’re going from 2% global annual energy growth demand for the past few decades to 6% to 8% over a couple of years, just because of AI. Everyone, including people who don’t agree with climate change, can see AI is driving energy demand from the data centers being added on. There’s some pressure from bitcoin too.

But back to sustainable infrastructure. In the early 19000s, we probably had the premier infrastructure globally. A lot of early wealth in this country was made on building our roads, pipes, and bridges. Now we lag terribly. A warming climate means the way we built our roads and bridges in the past is not sustainable going into the future. The Inflation Reduction Act provides a lot of fuel for infrastructure funding. So, investing in sustainable infrastructure just makes sense. You don’t have to get into an argument about what’s causing climate change. Things are warmer. That’s just a fact.

Norton: You mentioned one. What are the others?

Gitterman: Water is easy to discuss with investors. We have water shortages in major cities all over the globe, whether it’s Mexico City or Barcelona. AI demands a lot of pure water because you can’t use dirty polluted water for the chip manufacturing process. And a lot of water isn’t reusable because of pollutants from the chip manufacturing process. So, climate and AI issues overlap to drive the need for a lot of water investment in multiple areas, from piping and infrastructure to providing water for more fires in a safe and accessible way, to creating more drinking water. There are plenty of layers of investment. Historically, water has been an unbelievably great-performing asset with a lot of diversification to traditional equities.

Finally, climate adaptation, which is different from the conversation around decarbonization or eliminating fossil fuels from your portfolio. Adaptation comes in many forms. We like to focus on companies that access at least 90% of their revenue from sales related to a warming climate. So, whether that’s shoring up supply chains around food issues, providing heat pumps for a transition from traditional energy sources in buildings to the electrification of buildings, whether it’s fire-retardant specialists, which are much more in demand, or companies that make baffles that get put up around Tampa Bay Hospital that can protect from up to 15 feet of tide waters. We also have a fourth focus on social justice issues that are being compounded by climate change. But our three driving themes are infrastructure, water, and adaptation.

Norton: What does the Trump victory mean for climate investors and sustainable investors?

Gitterman: These themes are the most bipartisan themes we can find. Water, sustainable infrastructure, grid infrastructure, and companies that make money off climate resilience are immune to partisan politics. Specifically, for water infrastructure, support from the Inflation Reduction Act has been mostly going to red states. And climate resilience will be more necessary.

Norton: What about other climate themes?

Gitterman: I think climate mitigation [strategies that try to reduce the amount of greenhouse gases in the atmosphere to limit climate change] might be at risk. Also, environmental, social, and governance [ESG] strategies, which the Republican attorneys-general have been going after the past couple of years claiming that it’s collusion. [This year, the House Judiciary Committee claimed that a “climate cartel” of “left-wing activists and major financial institutions” are “collud[ing] to impose radical environmental, social and governance goals on American companies,” including decarbonization and net-zero emissions.]

We’ve been avoiding renewable energy for the last couple of years because of the interest-rate environment. Even when the rates come down, another problem is a lot of other people have been doing transition investing. China is impossible to compete with. That makes us nervous from an electric vehicles, solar, and wind perspective. When you’re financing the majority of the investment through the government, you can’t compete with the landscape. I don’t see a five-year window where those themes become really accessible in public markets without getting undercut by China the whole way along. Ford pivoted to commercial vehicles on EVs in China because he said there was no way they could compete with the Chinese. In the private markets, we’ve done a little bit of battery investing. We’re following that space as closely as we can.

Norton: Do you derisk your portfolio by owning these climate themes as a hedge?

Gitterman: It’s difficult. For the core portfolio, we work with managers who are taking climate change seriously and are looking at supply chain risk within the companies that they’re investing in, or at companies that are focused on a transition economy and trying to provide for net-zero commitments. We also have weighted themes in the portfolio but not in the core. Due to a warming climate, we use things like Probable Futures. Climate risk is a global phenomenon that affects local environments. We are likely going to have more droughts and more rain–but we can’t predict where and when. We have almost-zero real estate because we haven’t figured out a really good way to own real estate without taking on climate risk at this point. We haven’t held any emerging markets since covid because of supply chain risk around covid and climate.

Norton: You offer ESG solutions for other advisors. How do you benchmark them?

Gitterman: We have climate-themed unified managed accounts that can be individually customized toward client values. They’re based on separately managed accounts that are thoughtful and defensive around those three themes I mentioned and racial justice issues. KBI Global Investors manages our sustainable infrastructure fund. Water Asset Management manages our water fund, and Wellington Management runs our climate resilience fund. Adasina Social Capital manages our racial justice fund.

Water you’d have to compare with small caps, but you could run a good comparison of water versus the S&P 500 for the last 22 years. If you look at the Nasdaq eVestment platform, water is the number-one performing ESG fund over every period of time, specifically Water Asset Management. It’s done even better against small caps, which have underperformed.

Both KBI and Wellington are small to mid-cap. They’re holding up well. Wellington is a mix of 25 to 30 stocks investing directly in climate resiliency. It’s outperformed the S&P 500 over the last two years without owning any of the “Magnificent Seven” (Alphabet, Amazon.com, Apple, Meta Platforms, Microsoft, Nvidia, and Tesla). It offers a lot of diversification. KBI, because of interest rates, had a bit of underperformance over the last two years but had incredible outperformance during 2022 when the markets were all down. It’s a hedge against traditional equities right now. But historically, probably one of the better times to be investing in sustainable infrastructure is right now, as interest rates start to come down.

Norton: You would use these managers to replace existing equity categories. Wellington owns only a couple dozen stocks. Would you still use it to replace small- and mid-cap exposure?

Gitterman: We do our own macroeconomic forecasting and research and also utilize third-party data, which helps us decide how we want to be invested, for example, overweight US large-cap growth, underweight emerging markets, etc., geographically and across asset classes. Once we have this framework, we have a bespoke holdings-based manager ranking and scoring process, which helps us decide what strategies fit into our macroeconomic framework. Using this process, no one manager needs to serve as an asset class unto itself, because we look at the totality of our allocations and holdings to make sure that we are aligned with the macro. In the case of Wellington, it serves as a partial equity category allocation, but a full thematic allocation to climate adaptation.

Norton: Do these managers have US-registered funds or ETFs?

Gitterman: Not yet. But we also hold water through the Virtus Duff & Phelps Water fund AWTIX. We also use Water Asset Management’s SMA. We also hold GMO Quality Fund GQLIX, KraneShares Global Carbon ETF KRBN, First Trust NASDAQ Clean Edge Smart Grid Infrastructure Index Fund GRID. We also invest in Wellington’s Climate Resilient Strategy, which, outside of investing with us, is only available through a $50 million direct investment with Wellington.

Norton: What’s your view of fossil fuel-free funds as a substitute for traditional funds?

Gitterman: In full disclosure, we ran fossil fuel-free portfolios from 2014 until this year. We pivoted this year for two reasons. One, because of AI and energy demand and the lack of clear commitments to net zero from a lot of the big companies. Two, if you look at private investment in transition investments around climate, about 75% of those investments are being made by fossil fuel companies. They’re pouring billions of dollars into all kinds of technologies, whether it’s lithium mines that they’re buying, through ExxonMobil XOM or its battery companies that they’re buying, or wind technology.

We also have to think as fiduciaries for a client. You eliminate fossil fuels in our UMA model by adding a filter—clients can weigh in, so the UMA product is fossil fuel-free. In our mutual fund model, we stopped running a fossil fuel-free version this year. It’s very difficult to avoid this entire sector of the market when they’re spending that much money on a transitioning economy. We also invest in nuclear energy as well because there’s just no way we can hit net-zero commitments without nuclear. In the last few weeks, that space has blown up, with Amazon AMZN committing another $500 million, and Google GOOG agreeing to buy nuclear energy from small modular reactors developed by Kairos Power.

Norton: You aren’t investing in real estate. How does climate affect other asset classes and their investability?

Gitterman: The profile completely changes in fixed income because companies are making 20-year bets premised around climate risk that will impact reinsurance companies first. Reinsurance companies were free to raise their premiums as much as they wanted, then pass those premiums on to state insurance companies, which are restricted from raising their premiums for any reason and are capped by the voting authority. Those state insurers would then start to leave or exit states. As early as 2018, we wrote that they couldn’t afford the risk. It would translate into mortgage-bond risk, municipal-bond risk, and real estate valuation risk. That’s the domino playing out. Climate risks are exacerbating, and real estate valuations in climate-prone areas are actually going up because we have an aging population that is retiring and moving to California, Texas, and Florida.

My recommendation in real estate is to be cautious because you’re buying at a peak in markets that are heavily exposed to risk. As those risks play out, it gets harder to get insurance. Average state insurance for homeowners in Florida is about 50% to 100% higher than the rest of the country. Helene may be thought of as a pivot point where investment to adaptation resilience really started to take off.

Norton: Let’s talk about climate bonds.

Gitterman: You have sustainability-linked bonds and green bonds. We’ve been on the much shorter end of the curve. In the past, we invested with Calvert Green Bond CGAFX. Those are longer-term bonds, and we’ve been hedging the last two years and at a much shorter end of the curve. We’re not in them currently. We’re supportive of the space. You need a good manager like Calvert who is very thorough about making sure that the bonds we’re investing in aren’t just trying to pick up the initial premium of listing as a sustainability-linked bond or a green bond, and they’re actually investing in things that are changing the world. They’re not in our interest-rate profile at the moment but pretty close to getting back in. The Short Duration Green Bond ETF CCSB just came out. It’s too small for us to invest in currently, but I like the fund a lot.

Norton: How are you proxy voting for clients?

Gitterman: In the UMA product, we vote through Institutional Shareholder Services. We’re also looking at Iconik as a service, which allows for much more customization for registered investment advisors. We’re certainly not seeing the weight of investors playing out in boardrooms. I won’t name names, but bigger companies that control trillions of dollars of assets are typically not really voting in a way that’s shifting anything. And now, with the AI demand, we’re moving into a Cold War with China over AI. There’s a belief that AI will solve climate change. But people keep forgetting that AI is only as good as the information we feed it. It’s not thinking for itself, and it’s not going to do that for a while.

Norton: In the US, advisors may be wary of sustainability because of the conservative political backlash. How to avoid it?

Gitterman: It goes back to the three investment themes. They are even more important because of AI. They are easy to talk about. Water is an easy conversation. It doesn’t put you on either side of the political aisle. Sustainable infrastructure is still an infrastructure play. Why wouldn’t you want to build infrastructure that’s sustainable? Try to walk around Asheville right now. We’re trying to stick to themes that are not politically divisive but make absolute sense in a world where there’s more rain and more drought and more fires.

Norton: Thanks, Jeff.

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