Waking Up to Climate as a Financial Risk

New forecasting tools and fiduciary obligations provide the imperative for advisors to address climate change.

The aftermath of Hurricane Michael. Credit: Zack Wittman/Bloomberg

The aftermath of Hurricane Michael. Credit: Zack Wittman/Bloomberg

Despite the evidence, it’s not unheard of to find advisors who think of climate change as an ethical issue, rather than a financial risk. Andre Bertolotti, head of sustainable research and data at BlackRock, is sympathetic to such advisors who have historically underappreciated the financial risks posed by climate change.

“To many investors, climate risks, such as rising sea levels, can seem distant,” Bertolotti says. “Investors just didn’t have the capability to model these risks on an asset level before.”

The tide is shifting. Many of the tools that investors have been using make their forecasts using historical patterns. These tools are no long adequate for predicting risk, because extreme weather events are becoming more intense and more frequent. As climate science improves and more data becomes available, researchers like Bertolotti are able to drill deeper, bringing ever more sophistication to the analysis.

BlackRock has put together its own set of tools for assessing climate risks to portfolios. One heat map shows that 58 percent of U.S. metro areas will likely suffer annualized GDP losses of one percent or more by 2060-2080 if industry and regulators fail to take action on climate change. Among the likely losers: Arizona, the Gulf Coast region, and coastal Florida.

BlackRock’s analysis shows that physical climate risks vary by region from hurricane-force winds and flooding risks to real estate in cities like Houston and Miami, to the rising share of municipal bond issuance from regions facing economic losses from climate change and related events.

Nonetheless, climate risk can become invisible to advisors and investors that focus exclusively on short-term returns, or those who are only evaluated against a market-relative performance benchmark.

But Keith Johnson, a lawyer who advises institutional investors on fiduciary duty, says that intergenerational risk provides a fiduciary imperative to consider climate change as a financial risk. He says systemic risks can spread across portfolio companies and compound over time, increasing risk exposures and degrading future returns of younger fund participants: “Because it usually takes time for systemic issues to become manifest, the potential for inequitable intergenerational treatment in the resulting transfer of risk and value is high”.

That’s a problem, since investors and advisors have a fiduciary duty of impartiality. A transfer of risk of this nature could make it more difficult to prove that advisors have reasonably balanced the interests of different groups – such as younger and older fund participants.

All of this poses risks to investors who might be on the hook for losses. But BlackRock’s Bertolotti says it’s important to note that while climate change presents investment risks, it also generates opportunities.

Private markets are the best source of exposure to themes connected to climate change. Mercer identifies low-carbon indices and green bonds as potential areas of investment for investors. It also identifies sustainable infrastructure as a potential area for investment.

The global requirement for new infrastructure assets is expected to become $90 trillion more than the value of the world’s existing infrastructure stock from 2015 to 2030 through global population growth and urbanization, according to the New Climate Economy. However, many investors have not yet developed a formal approach to sustainable infrastructure.

Retail interest in sustainable investment has been increasing, but advisors should see the shift as both an imperative and an opportunity. Bertolotti says: “Companies that can take advantage of emerging technologies, societal trends and regulatory changes are poised to do better over the long-term.”

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