Responsible Investing: How can climate change impact your investments?

Glaciers are shrinking, and sea levels are rising. Low-lying communities are getting flooded, while wildfires are ripping through forests. The planet’s climate is changing in dramatic ways, and the scope of the damage isn’t limited to the environment. Extreme weather could pose more risks to your portfolio than you think.

Analysts have already begun to count the cost of global warming to the economy. In November 2018, a U.S. government report warned that if no significant policy changes were undertaken to rein in global warming, the world’s largest economy would shrink by about 10 percent by 2100—almost double the losses of the Great Recession a decade ago. In the U.S. alone, the cost to the economy could exceed US$500 billion annually by the end of the century, according to media reports1.

“Unmitigated climate change would be disastrous for investor portfolios as extreme weather would have an impact across every sector that would be hard to completely avoid,” says Jamie Bonham, Manager of Corporate Engagement with NEI Investments, Qtrade Investor’s affiliate company. “Think of resorts based in low-lying areas that will be prone to rising seas and increased flooding, infrastructure in areas with increased hurricane activity, water-dependent industries in increasingly water-scarce regions.”

In Canada, the central bank’s deputy governor said that climate change could cost the country between $21 billion and $43 billion each year by the 2050s if global warming continues unabated. Climate-related risks have already started to take their toll on the economy. For example, the wildfires that tore through Alberta in the spring of 2016 reduced Canada’s GDP by about one percent in the second quarter of that year2.

Financial risks of climate change

As the world braces for more extreme weather events, the Bank of Canada has started to take action to address climate change. For the first time ever, in May 2019, the central bank released a report that sheds light on the threats climate change poses to the country's financial system3. In fact, the bank has listed climate change among the six major vulnerabilities threatening Canada’s economy. One of the biggest challenges facing corporate Canada lies in the transition risks from adapting to a lower-carbon economy.

“This speaks to the risks faced by oil and gas companies, utilities, mining and other high-carbon sectors,” Bonham explains. “Basically, if the world no longer needs the products you produce or if regulations greatly increase your costs, for example through a price on carbon, that is a clear business risk.”

Lower demand, increasing cost of production and regulatory changes are among the climate-related risks which can lead to “stranded assets”—assets which can no longer generate a sufficient economic return. Shareholder value is impaired when these assets are devalued or written off on a company’s balance sheet.

Under the Paris Accord, Canada committed to reducing its greenhouse gas emissions in order to contribute to the goal of limiting global warming to less than 2°C. To honor this commitment, Canada has to shift to a greener economy. In a resource-dependent economy like Canada’s, such a transition will impact many businesses.

“Essentially, any sector that is associated with high COemissions is at risk. This would include sectors such as the cement and steel industries, which currently have very high carbon footprints due to the inherently high-carbon oriented processes they use to create their products,” Bonham points out.

The insurance sector, in particular, is reeling from the negative effects of climate change. Hit by enormous claims associated with wildfires, floods and hurricanes, insurers are sounding the alarm about the possibility that climate change could make coverage for ordinary people unaffordable. Agriculture and food retail sectors are also vulnerable to climate change.

“A changing climate will have dramatic impacts on the supply chain that brings food to our tables,” Bonham warns. “Some of these costs will be passed on to consumers, but in the case of extreme weather events, it could lead to dramatic losses for industries. Think of losing your entire crop to extreme drought or flooding.”

Opportunities in greener portfolios

Just as extreme weather could drastically change the investment landscape, opportunities could emerge when investors, along with consumers, pivot towards a lower-carbon global economy. As with any emerging sector, it can be challenging to pick the companies that will emerge as leaders. However, companies that find solutions to climate change will attract capital and play a vital role in mitigating the economic impacts.

“There is a desperate need for capital to support the growth of innovation in renewables, energy efficiency, waste recovery, industrial processes and more,” says Bonham.

Joining the sustainability conversation are several oil and gas industry leaders who are exploring how they can fit into a low-carbon transition.

“Some of the players in the oil and gas sector are actively grappling with how to plan for the reality of a lower-carbon economy. That means if you’re committed to positions in the oil and gas sector, it’s possible to back the more progressive firms that are taking a longer-term view,” explains Bonham, adding that opportunities will also arise from investing in solutions that will sustain life.

“Water treatment is a great example. Water availability is going to be a huge issue globally, and it’s going to get much worse in areas that are arid.”

As an investor, one way you can make informed decisions about the security of your investments is to take steps to investigate if the companies you hold have a progressive climate change strategy. You can also seize investment opportunities with companies that are working towards reducing their emissions and finding innovative solutions to lessen climate change impacts. Transitioning to ETFs or funds that have a sustainability theme is one route you can explore.

It’s also important to find out if the companies you invest in are transparent about their impact on climate change. Do they have a credible strategy in place to ensure they’re not actively exacerbating the situation? Have they adopted a climate policy that helps make the transition to a low-carbon future? If you’re buying into investments managed by third parties, make sure the manager is aware of climate change risks and is engaging with the companies in your portfolio to discuss solutions.

If you want to re-imagine your portfolio, you can identify sustainability-oriented investment opportunities. You can discover which companies are leaders in adapting to climate change or investing in solutions by exploring sources such as MSCI ESG indices, Dow Jones Sustainability Indices, Corporate Knights and the Global Sustainability Leaders Index.

“There’s a path that points to where opportunities are going to come from, and these include companies that implement a thorough transition strategy and work hard to mitigate climate-related risks,” says Bonham.

Interested in learning more about responsible investing?

Visit the NEI website and click on Responsible Investing for articles, whitepapers and other resources.


Resources:

1Georgiou, Aristos. “Climate change is already costing America $500 billion a year—and this is just the tip of the iceberg.” Newsweek. November 29, 2018. https://www.newsweek.com/climate-change-already-costing-america-500-billion-year-and-just-tip-iceberg-1237143

2Lane, Timothy. “Thermometer Rising—Climate Change and Canada’s Economic Future.” Bank of Canada. March 2, 2017. https://www.bankofcanada.ca/2017/03/thermometer-rising-climate-change-canada-economic-future/

3Roman, Karina. “Climate change threatens 'both the economy and the financial system,' says Bank of Canada.” CBC News. May 16, 2019. https://www.cbc.ca/news/politics/climate-change-bank-of-canada-financial-system-review-1.5137625