How the threat of climate change can be an opportunity for investors

A Brief Summary

  • Context – Why the physical effects of climate change will affect investors
  • How these changes will affect the globe and the financial sector
  • Why there are opportunities for investors to take advantage of changes in climate

Why does this matter?

Regardless of whether it is real or not, governments, industries and consumers have moved climate change to the top of their agendas.

This transition represents an area of opportunity. It will allow wily investors to profit through the integration of environmental factors into their investing processes (more on that later). Understanding the interaction between finance and climate has never been more important.

Implications of climate change are one of the major debates of the 21st century. In the world of finance, this uncertainty is one of the reasons investors have been slow to react to climate factors.

The world is facing an unstoppable rise in adaptation and mitigation efforts to combat climate events. There is a growing international focus on implementing climate regulation. As a result, pressures on companies and asset owners to support sustainability are increasing.

Through the Paris Agreement, and despite the withdrawal of the US from its previously agreed climate policies, the national climate plans that support the agreement will need an investment of approximately US$1.5 trillion a year by 2020. A transition to a low-carbon economy will also require embracing more sustainable finance.

You might be wondering “how is climate change related to my investment decisions?” Unfortunately, there is no sole answer to this. Climate change can impact the performance of investment portfolios in many ways.

What’s coming?

This blog will cover the greatest threat climate change poses to the financial sector. Due to its sheer magnitude, nearer term, irreversibility and limited risk reduction options.

This threat is no stranger to us. It comes in the form of weather extremes and climate variability. If you have read up to this point, then (unlike some prominent world leaders), you are probably familiar with the most widespread extreme weather events due to climate change. Yet, it is essential to further understand them to recognise the need for a change in the nature of global finance. With the aim of achieving more sustainable financial practices.

Here are some of the imminent problems facing the globe:

Region Key Risk Economic Impact
Europe Extreme heat Affects health, wellbeing, labour productivity, crop production and air quality
North America Wildfires and urban floods Loss of ecosystem integrity, property loss and even human mortality
Asia Coastal flooding and critical temperature increases Widespread damage to infrastructure, livelihoods and settlements
Africa Heat and drought stress Reduces crop productivity and creates adverse effects on livelihood and food security
South America Reduced water availability Decreases food production and food quality
Australasia Significant damage to coral reef systems Loss of entire ecosystems

These extremes and climate variations are expected to increase in frequency and intensity in the upcoming years. Each time increasing the consequential economic losses.

One important question to raise, is whether increases in economic wealth in specific regions, increases the propensity of suffering greater economic losses when affected by climate extremes.

We cannot escape the effects of climate change. Alas, the same phenomena applies to your investments; no matter where you allocate, they will always be subject to climate risk.

To illustrate the magnitude of the potential effects of climate extremes on investments; in 2015, the European Union registered EUR€11.85 billion in losses caused by natural hazards.

US losses from the same source and across the same time-period accounted for US$21.9 billion.

In the first half of 2017 alone, the US experienced 9 extreme climate events, each causing losses that exceeded US$1 billion each.

But the damage does not end there. For the period between 1980 and 2015, the economic losses of all natural disasters in the European Union totalled EUR €520 billion. The corresponding insured losses were approximately EUR €154 billion (2015 values).

Insurance companies play a key role in the efforts to adapt to extreme climate events.

Events of this nature often affect specific regions in great scale. Insurance companies face the challenge of having to cover the damages of all the policyholders in that area. This can lead to great economic losses if the policies were not priced considering climate risk. Insurance companies manage a third of the world’s investment capital, with around US$30 trillion in assets. Of this, US$4.2 trillion is exposed to climate risks.

Surprisingly, only 8% of insurance companies have staff dedicated to integrating climate risk into the investment process, compared with 16% of pension funds. Furthermore, only 3% have a policy setting out how they engage with investment companies on climate risk, versus 15% of pension funds.

The good news for investors

So far we have only covered the risks exacerbated by the physical impacts of climate change. But at the beginning of this blog, I said these risks also provided an area of opportunity for investors to exploit.

What attractive investment alternatives have emerged from this global efforts to tackle climate change’s physical impacts?

Infrastructure investment is the key

The 2016 New Climate Economy Report on Sustainable Infrastructure expects the demand for infrastructure will require an investment of US$90 trillion over the next 15 years.

This represents an ideal opportunity for developers, governments and investors to fund sustainable infrastructure that will

a.) meet the global infrastructure demand while reducing carbon emissions, and

b.) provide adaptive solutions to climate extremes.

According to the Global Commission, the additional upfront costs of ensuring new infrastructure is compatible with climate goals can be offset by efficiency gains and fuel savings over the infrastructure lifecycle.

By now, most investors should recognise that it pays to take into account the environmental factors that affect companies. Failing to prevent the physical impacts of climate change has proven to inflict devastating financial consequences for companies. We can assume that the more sustainable investments are conducted today, the more likely it is to earn revenues in the future.

If you would like to learn more about Redington’s approach to environmental and socially responsible investing, please get in touch with honor.fell@redington.co.uk.

Also, be sure to check out the next quarterly Asset Class in early October, explaining our approach to assessing Environmental, Social and Governance.


References in order of appearance:

https://www.blackrock.com/investing/literature/whitepaper/bii-climate-change-2016-us.pdf

http://greenfinanceinitiative.org/wp-content/uploads/2016/11/Globalising-green-finance_AA3.pdf

http://www.ipcc.ch/pdf/assessment-report/ar5/wg2/ar5_wgII_spm_en.pdf

https://www.eea.europa.eu/data-and-maps/indicators/direct-losses-from-weather-disasters-3/assessment

https://www.ncdc.noaa.gov/billions/events/US/2015

http://aodproject.net/insurers-lag-behind-pension-funds-on-tackling-climate-risk-threatening-financial-shock/

http://newclimateeconomy.report/2016/

 

Author: Javier Arias

Javier completed a BSc in Financial Management in Mexico and is currently doing a Masters in Climate Change at Imperial College. Javier’s hobbies include running, football, tennis, weight training and fantasy reading.

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