Blackrock Investment Institute (Blackrock) has released a call-to-arms for investors, stating they can no longer ignore climate change. Climate change risks have been underappreciated, and carbon significantly under-priced, according to the report. It finds that although market carbon prices are not yet reflective of realities, they soon could be, which would increase both investment risks and opportunity.

The report finds that irrespective of investment sector or size, climate change will increase investment risks, and failure to take this into account could breach director's fiduciary duties. As environmental, social and governance (ESG) data increases in both scope and accuracy, it is increasingly important for investors to consider. The UN has called for climate to be factored into responsible investment, which is beginning to trickle down into domestic laws. The report identifies four forms of climate change risk:

  1. Physical. Climate change is increasing natural disasters and extreme weather patterns which are difficult to model and can threaten physical investments. Reducing a portfolio's carbon footprint can mitigate this risk in the long term, and exposure to this risk increases with the investment term. In our own experience, many of the impacts of climate change are already having a significant impact on a range of sectors like agriculture and we believe these changes are not well understood or appreciated by investors.
  2. Technological. As new technologies are developed, low-carbon energy is becoming cost-competitive, but will take time to become fully investable. Thus selectivity is key to minimising portfolio risk. The report argues that fossil fuel investments with minimal exposure to stranded assets will perform better in the short-term, although long-term investment may increase exposure to this risk.
  3. Regulatory. Governments are increasing disclosure requirements for climate-related data from companies in attempts to accurately regulate climate change, creating short term sovereign risk for both cash flows and compliance. Investors who stress-test their climate risks voluntarily may face short term compliance costs, but long-term costs will be decreased by such early action. In our own experience, increases in international and domestic regulation of actual GHG emissions are increasingly placing a price on carbon.
  4. Social. Social media combined with social awareness has increased pressure for companies to maintain sustainable supply chains, which applies equally to climate-conscious investment.

While the risks posed by climate change will apply across the board, only climate-smart investors can leverage its opportunities. Blackrock suggests that by integrating climate factors into investment portfolios investors can generate high returns. This will require optimization against a benchmarked climate scoring framework, and Blackrock suggests a six-course 'menu' for this, consisting of:

  • Developing a starter package of ESG data
  • Maintaining climate-friendly indexes
  • Hedging geographic and revenue exposure to climate risk
  • Measuring carbon emissions
  • Leveraging off big data analytics
  • Heeding sovereign risk

Blackrock suggests integrating climate change mitigation into the investment portfolio gradually, by re-investing mature bonds into green and cleantech bonds. To generate alpha returns, Blackrock recommends undertaking detailed research into ESG factors and mining climate data, the value of which will increase along with the above risks. Blackrock recommends asset owners and managers take steps in data collection and integration surrounding their exposure to climate change risks, and integrate these findings into their investment portfolios, engaging with both traditional and emerging sectors to simultaneously reduce exposure to these risks and diversify portfolios to maximise these opportunities.

In our own view, the need for such investor assessment is even more critical with the coming into force of the Paris Agreement under which individual country Nationally Determined Contributions set the agenda for reaching the Paris mitigation goals through the transitioning of economies on a low carbon growth path. This creates substantial opportunities for private sector investment into the reshaping and growth of such economies. In this respect the Blackrock report could not be more timely.

To read the Blackrock report in full, please visit the link below: