The investment case for taking climate change seriously

4th November 2015


Ewen Cameron Watt, chief investment strategist at BlackRock looks at climate change as a key risk factor and an emerging investment theme…

Even if you are sceptical of global warming and its causes, no one should ignore that significant regulatory, economic and technological factors make this a major investment issue. Investors, corporations and governments are focusing on the risks and opportunities, as well as how best to tackle the challenges that are arising. These profound changes have the potential to affect asset prices in all areas for a long time to come.

Climate change risk has arrived as an investment issue. Governments are setting targets to curb greenhouse gas emissions. This may pave the way for policy shifts that we could see ripple across industries. The resulting regulatory risks are becoming key drivers of investment returns.

The momentum behind mitigating climate risk in portfolios appears to be building. Long-term asset owners worry about extreme loss of capital and/or ‘stranded’ assets (write-downs before end of their expected life span). Do securities of companies most susceptible to physical and regulatory climate risks already trade at a discount to the market? We have not observed such a discount in the past – but could see one in the future.

Global insurers have led the way in pricing natural disaster risks. A huge US storm in 1992 (Hurricane Andrew) almost wiped out the industry, leading to a revolution in how it underwrites risks through an influx of capital, use of big data and increased capital requirements. Other industries may need to catch up.

We view environmental, social and governance (ESG) excellence of asset owners as a mark of operational and management quality. It means responsiveness to evolving market trends, resilience to regulatory risk, and more engaged and productive employees.

Divesting from climate-unfriendly businesses is one option. The biggest polluting companies, however, have the greatest capacity for improvement. Engagement with corporate management teams can help effect positive change, especially for big institutional investors with long holding periods.

Climate change related data can be used to measure physical and regulatory environmental risks, to mine for alpha opportunities or to reflect social values in portfolios. As examples, we analyse the carbon intensity of an insurer’s corporate debt portfolio and discuss research that ties improving carbon efficiency to equity outperformance.

Securities markets are evolving to include emissions trading and green bonds, enabling investors to limit carbon exposures in portfolios and direct capital to projects that reduce emissions. Putting a price on carbon emissions is key for determining the value of energy-intensive industries, we believe. Carbon prices are mostly driven by policy, however, and currently offer little incentive to force emitters into palliative action and consumers to switch to non-fossil fuels.

Efforts to mitigate climate change will produce winners and losers – but maybe not always the obvious ones. The oil industry and energy-exporting countries may look like losers, yet low-cost operators should do fine as de-carbonisation will likely be gradual. Assets that may benefit from a transition to a low-carbon economy include renewable infrastructure debt and equity. We also like selected companies specialising in energy efficiency and clean technologies.

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