Why Investors Need to Act Now on Climate Change
Are there any such things as climate change investment opportunities? Since the publication of the Stern Review on the Economics of Climate Change late in 2006 there has been a significant increase in the awareness and understanding of the enormous climate-related economic and financial risks the world faces.
These risks are characterised by high levels of uncertainty and a need to monitor extreme scenarios and so-called ‘tail risks’ (the possibility that an unlikely event will occur and result in a significant loss).
Climate change investment opportunities?
Climate change will affect both the value of assets and the capital return on assets over the long-term, which is why understanding its impacts is relevant to the fiduciary duty owed to savers and fund beneficiaries.
The risks are becoming clear but will there be any climate change investment opportunities?
According to a recent report by Client Earth (https://www.documents.clientearth.org/wp- content/uploads/library/2018-08-13-why-investors-should-act-in-response-to-climate- related-risks-and-opportunities-a-survey-of-current-evidence-coll-en.pdf), a non-profit environmental law organisation, investors and investment managers need to pay particular heed to the questions below:
What risks does climate change pose to the value of and income from financial assets and portfolios?
What are the financial (transition) risks for high-carbon and fossil fuel assets, including the risk of asset stranding?
What are the risks for investments in sectors with secondary exposure?
What evidence is there that climate risk is not adequately priced into the market? Does climate change offer any investment opportunities?
The evidence shows that clear trends are emerging and irreversible shifts underway, although the impacts of climate change are almost impossible to forecast at a social and political level.
These changes will have highly significant impacts on the success, income and value of companies directly exposed to climate change risks (e.g. fossil fuel companies), on sectors with secondary exposure (including banking and finance, insurance, transport, and construction) and the economy as a whole.
Climate-related risks
Risks and opportunities related to the climate and energy transition can be identified and factored into investment strategies and decisions, as well as company business models, although this is not yet happening to the extent required.
Some markets are not adequately pricing in climate risks and opportunities and so long as this continues the prospect of more substantial disruptions, shocks and sudden corrections is becoming an increasingly significant risk factor.
Investors need to position their portfolios to take advantage of trends that can be identified now and be resilient to unpredictable disruptions and shocks that may manifest in future.
Integrating climate risks into investment policies
Integrating climate risks into investment policies, strategies and decisions is becoming easier.
The legal and regulatory frameworks are being progressively clarified, assuring boards and trustees that perceived barriers to pension funds (and investors) integrating climate risk factors are often based on misunderstandings or are surmountable.
Pension funds and other investors are already changing their strategies to ‘tilt’ portfolios towards low-carbon and climate-resilient sectors, to divest from high-carbon industries like fossil fuels, and to invest in areas of opportunity like infrastructure and renewable energy technologies.
The market is responding to provide better and more cost-efficient solutions to investors’ needs and to ensure these are adaptable to fit the specific approaches and needs of different customers including those of long-term investors like pension funds.
Market analysis is showing that climate-tilted investment portfolios and benchmarks can match, and in some cases outperform, standard benchmarks on measures including overall returns, risk-adjusted returns and income.
‘Wait-and-see’ approach is now tricky to support
Some climate-aligned sectors such as green infrastructure and renewable energy offer the prospect of return characteristics that are in many ways at least as good a match for the needs of investors like pension funds (e.g. for reliable and consistent income in the long-term) as traditionally vital sectors like oil and gas.
Overall, the imperative to act in response to climate-related financial risks and opportunities is becoming clearer all the time while the case in favour of a ‘wait-and-see’ approach is now tricky to support.
The question now is ‘how’, rather than ‘if’, investors should integrate climate risk into their investment strategies and decisions.
The time to act is now.
Paul Connolly
Paul Connolly has been a journalist for more than 20 years, as a reporter and editor for Argus Media, Reuters, The Times, Associated Newspapers and The Guardian. He has covered Islamic Finance for Reuters in the 1990s. Paul has since helped launch three newspapers, as well as reported from Tokyo, Los Angeles and Stockholm.
