Risks and Opportunities From the Changing Climate: Playbook for the Truly Long-Term Investor

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  • Considering climate factors is an economic risk management and opportunity capitalization issue core to prudent investing for the long term. As a possible systemic driver of more frequent and/or severe weather events over the coming decades, climate change—defined as the long-term evolution of global and regional
    weather patterns driven by the rising level of greenhouse gas emissions—has the potential to materially impact businesses, economic assets, and communities. Potential impacts include direct effects on real property and supply chains, economic consequences from policy and regulatory responses to climate change, and/or indirect effects on financial markets at a global scale through the heightening of broader uncertainty and risk aversion.
  • As part of incorporating climate risk into long-term investment decision-making, investors should consider whether and how to stay ahead of the climate risk curve to preserve value in their portfolios (“defense”), as well as whether and how to position themselves to capitalize on investment opportunities arising from technological advances, business model innovations, and policy evolution (“offense”). For many, the first step is not necessarily making immediate portfolio changes, but rather asking key questions to establish guideposts today to arrive at better decisions tomorrow.
  • Given the interconnected and systemic nature of climate risks, investors will find it difficult to predict and precisely manage every potential impact on portfolios. However, we have identified four approaches investors can take to better understand and manage these risks: (1) engagement through delegation to managers, asking them to consider incorporating climate risks; (2) engagement through advocating for more transparency and reporting on climate risk metrics, while overlaying a climate risk lens to the due diligence and monitoring process; (3) proactive hedging via low-carbon index products, derivatives, or use of active managers that employ environmental, social, and governance (ESG) metrics; and (4) policy-level exclusion of fossil fuel and other sectors. Not all these themes are appropriate for all investors, and some will pursue none or only a few of them. But considering the options will enable long-term investors concerned about climate risks to craft their own strategy reflecting their views and objectives.
  • Beyond defense, investors should consider proactive, solution-oriented strategies to capitalize on investment opportunities linked to climate change. Our basic thesis is that the more challenging the problem, the greater the opportunity set for innovations, solutions, and, ultimately, attractive investment returns. We identify five current themes: renewable infrastructure, clean transportation, smart energy, energy efficiency in buildings, and water and agricultural efficiency. Attractive risk/return profiles exist in select areas within the broader “resource efficiency” arena. The themes discussed and the various approaches to access them are neither all-inclusive nor static, as new themes can emerge and existing themes can evolve over time. The objective for truly long-term investors is not only to identify and evaluate the available and accessible investment opportunities today, but also to uncover and capitalize on the opportunities that will present themselves in the future.
  • Both strong defense and offense are important to manage risks and capitalize on opportunities associated with climate change. Long-term investors would benefit from properly integrating defense and offense into a cohesive investment strategy aligned with their own views and motivations.
  • We continue to seek and refine effective approaches to understand and manage risks amplified by climate change, and search for positive returns from capturing the value created by businesses and assets that play a role in the world’s gradual transition to a lower-carbon and more resource-efficient economy. These opportunities are and will continue to be driven by a combination of technological and business model innovations, policy and regulatory shifts, and, perhaps more fundamentally, the human entrepreneurial spirit that is drawn to creating real solutions to large problems.