In 2021, almost one in three Americans experienced a weather disaster, and even the fact that these events are now mostly described as “weather disasters” rather than “acts of God” illustrates our new understanding that what’s happening isn’t some cosmic game of chance – we’re causing this. The Intergovernmental Panel on Climate Change (IPCC) issued its sixth assessment report on the physical science basis of climate change in 2021, and in contrast to past reports, in which warnings were couched in scientific estimates of uncertainty, the conclusions were written in plain language: “It is unequivocal that human influence has warmed the atmosphere, ocean and land ... The scale of recent changes across the climate system as a whole and the present state of many aspects of the climate system are unprecedented over many centuries to many thousands of years.”
Climate change is not a distant threat: heavy costs are being borne here and now. During 2021, we saw deadly floods in western Europe, where as much as two months’ worth of rain fell in two days. Flooding also hit central China, where a three-day downpour delivered a year’s worth of rain in one city. A “heat dome” that enveloped much of the Pacific Northwest and Canada during the summer of 2021 caused several hundred deaths and damaged transportation infrastructures and crops. Fires forced evacuations and damaged property and infrastructure in the American west, the Mediterranean and Russia. One company has even been charged with manslaughter in the deaths of four people caught in a wildfire found to have been caused by company’s inadequate management of its transmission assets. This is just a sampling of the impacts of climate change-related extreme weather in 2021.
But today’s costs pale in comparison to what future costs and damages will be. A recent report from Swiss Re contained the sobering estimate that climate change could cost the world 10 per cent of its total economic value by 2050 if we stay on our current warming trajectory. By contrast, by investing the money needed to prevent warming above 1.5 degrees – the threshold under which we must stay to avoid climate catastrophe – the estimated negative impact on gross domestic product (GDP) would be reduced to about 4.2 per cent by mid-century.
The damages, costs and suffering caused by climate change can be mitigated because we have the capacity and the technology to prevent these from becoming significantly worse. Investing now in low-carbon technologies and solutions is, in fact, likely to be less expensive than coping with increasingly severe and frequent disasters and heat waves. The IPCC estimates that it will take US$1.6-3.8 trillion every year to avoid surpassing 1.5 degrees in additional warming between now and 2050. That is a hefty price tag, but these investments will also create jobs and add to economic output, unlike the damages and losses incurred by extreme weather and the chronic effects of climate change. Investing in both mitigation of additional emissions and adaptation to the changes that are unavoidable will be a far less chaotic approach to the problem of climate change than simply awaiting the effects.
But investing in mitigation need not undermine financial outcomes for both equity and fixed income investors – in fact, it should be profitable. Investing in mitigation and low-carbon solutions, or at least incorporating both transition and physical risks into investment portfolios, can provide competitive financial results to investors.
There is growing body of research demonstrating that decarbonisation does not have to involve performance trade-offs. In fact, several new studies show that carbon-sensitive portfolios may outperform less carbon-sensitive peers. Past performance is not indicative of future returns.
Harvard Business School in 2019 found that portfolios that “lowered carbon emissions more aggressively performed better”. Using the authors’ concept of decarbonisation factors and constructing portfolios that take long positions in low carbon intensity sectors and short positions in high carbon intensity sectors provided significantly positive alphas when buys and sells were coordinated with institutional flows into the factors. Past performance is not indicative of future returns.
Other approaches have proven to be interesting as well. In another 2019 study, Christina Atanasova and Eduardo Schwartz examined North American fossil oil firms between 1999 and 2018 and documented that the growth of fossil fuel reserves has a negative relationship with firm value. They found that the negative impact of reserves growth was due to firms adding to undeveloped reserves. Past performance is not indicative of future returns.
Taken together, these studies suggest that investors do see climate change as a material set of risks – and in the case of energy firms, even an existential one.
Julie Gorte, senior vice-president for sustainable investing at Impax Asset Management.