Boston, MA (May 10, 2016) – In the face of the real and perceived risks emanating from climate change, smart institutional investors should consider taking five steps both to defend against long-term market risks and to look for attractive investment opportunities in emerging sectors and technologies, according to global investment advisor Cambridge Associates.
“While one might categorize climate change as a ‘tail risk’ – a low-probability event with large magnitude consequences – it is probably more appropriate to categorize it as a series of events with uncertain timing and magnitude of consequences,” says Liqian Ma, a managing director at Cambridge Associates and author of the report, “Risks and Opportunities From the Changing Climate: Playbook for the Truly Long-Term Investor.”
Given this unique risk management challenge, long-term investors would benefit from recognizing and integrating climate change as a real economic factor in positioning portfolios for the future. Doing this, Ma says, translates into five tactics:
- Playing Defense Against Ecological Risks. Investors should ask their managers to take the ecological risks of climate change – more frequent and/or severe weather events – into account. The belief here is that the ecological effects of climate change may impair real property and infrastructure assets, disrupt supply chains, impact fiscal and geopolitical stability in certain regions, and increase societal risk aversion more broadly. For investors, engaging with managers is critical to better understand, and eventually manage these risks in portfolios.
- Monitoring Global Policy Risks. Policy changes – human responses to the expected effect of climate change – may occur regardless of the scale of ecological change. For example, President Obama recently signed the Paris Agreement, along with 170 other countries, on Earth Day. The carbon emissions reductions agreed to in Paris last year may have long-term effects on some high-carbon assets and sectors. To lessen the effects of these policies, as well as others that may occur in the future, investors should look for managers with deep, real-time understanding of regulatory dynamics. Some investors are also allocating to low-carbon index funds, which exclude companies with the dirtiest carbon footprints, or seeking out active managers that integrate environmental metrics into their strategies to mitigate regulatory and policy impacts.
- Identifying Compelling, Climate Change-Driven Opportunities. Institutions may seek out emerging sectors – in areas like renewable infrastructure, clean transportation, smart energy, energy efficiency in buildings, and efficiency in water and agriculture – that will allow businesses and individuals to use resources more efficiently and at lower costs, and may present attractive opportunities for investors. “A changing climate carries immense potential risks for investors and society. But we believe that the more challenging the problem, the greater the opportunity set for innovation, solutions and, potentially, attractive investment returns,” says Ma.
- Recognizing that Resource Efficiency Sectors and Managers are Evolving. Many investors were burned by clean tech investing in the 2000s, but those memories belie strong recent performance from some underlying subsectors. For example, investments in Smart Grid technology have produced a 25.9% gross internal rate of return (IRR) according to the Cambridge Associates Clean Tech Company Performance Benchmark as of September 30, 2015. Though some investors may justifiably be wary of clean tech because of the broad sector’s challenging historical experience, investors should remember that the sector is continuously evolving and many managers and entrepreneurs are adapting their strategies accordingly.
- Playing Both Offense and Defense. Institutions and families with a long-term time horizon will need to play both offense and defense to most effectively navigate the impacts of climate change. Managing risks and capitalizing on opportunities associated with climate change will not be easy, but forward-thinking investors are already developing playbooks for effective portfolio construction, and integrating them into a strategy that aligns with their missions and values.
Long-term institutional investors should stay abreast of the continued evolutions in both risk factors and opportunity sets involving climate change. Jessica Matthews, head of Cambridge’s Mission-Related Investing Practice and a contributor to the report, said that the moment had passed when investors had the luxury of whether or not to take account of climate change. “That particular train has left the station,” she says. “It’s no longer a question of ‘whether’ to respond to the risks but ‘how.’”
This press release is provided for informational purposes only and is not intended to be investment advice. Any references to specific investments are for illustrative purposes only. With regard to any references to securities indices, such indices are unmanaged and are not subject to fees and expenses typically associated with managed accounts or investment funds. Investments cannot be made directly in an index. The information herein does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. This release is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction. Past performance is not a guarantee of future returns.
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