Why should investors care about climate change?

Jessica Ground, Global Head of Stewardship for Schroders

Climate change is impacting our daily lives at a faster rate than ever before and South Africa is no stranger to its effects. However, the physical risk posed by climate change is often overlooked. The financial implications of damage to physical assets can be costly and investors should actively engage with management teams to ensure they fully understand the risks associated with inevitable climate changes.

What does climate change look like at the moment?

At Schroders, we actively monitor 12 climate change indicators to assess how well the global economy is progressing towards a lower carbon world. Our Climate Progress Dashboard provides us with a bird’s eye view of the speed and scale of climate action across the spectrum of areas that will need to change. It currently suggests that we are heading for a global temperature rise closer to 4°C than the 2°C commitment global leaders made in Paris in 2015. This is hugely concerning and means that investors should be acutely aware of the potential impact that the rise in global temperatures can have on their investments.

How can climate change impact my investments?

There are two main focus areas that investors should consider when it comes to assessing the impact of climate change on their investments.

- Regulatory risk: As governments introduce measures to meet their carbon-reducing commitments, companies (particularly those with high greenhouse gas emissions) will face increased regulatory pressure. For example, the implementation of policies such as carbon taxes can impact a company’s cashflows while increased measuring and monitoring of a firm’s carbon emissions will push costs higher. Issues such as the increased possibility of litigation costs if a company fails to mitigate their emissions are also becoming more and more real.

While these are all important considerations, investors often neglect to thoroughly understand just how vulnerable a company’s physical assets and infrastructure are to severe disruption and damage as a direct result of extreme weather.

- Physical risk: It’s not only bricks and mortar at risk, but supplies, equipment and human capital. Weather events that prevent employees from getting to work, that destroy equipment, interrupt operations or stifle productivity will clearly end up costing a firm, with consequences for shareholders.

How can companies protect themselves?

Theoretically, firms can insure themselves against such physical damage. The Schroders Sustainability team has created a physical risk framework which calculates the amount of insurance businesses would have to pay to protect their physical assets against weather-related hazards.

Which sectors are most affected?

We applied this framework to more 10,000 companies globally and found that predictably, capital-intensive sectors operating in more vulnerable parts of the world face the biggest impacts, whereas those with asset-light business models are least exposed. We have identified oil & gas, utilities and basic resources as the sectors most exposed to the physical impact of climate change. The potential cost of insuring their physical assets equates to more than 3% of their market values.

The sectors least at risk are those with generally asset-light business models including technology, personal & household goods and healthcare.

Figure 1: Sector exposures vary according to capital intensity

Investors should be actively engaging

The cost of insuring against physical damage to operations and infrastructure is significant and is something investors need to have an in-depth understanding of. This is particularly the case in the capital-intensive industries such as oil & gas, utilities and basic resources, which according to our analysis, are at greatest risk of prohibitive insurance costs.

Active engagement with company management is the best way to thoroughly assess and fully appreciate the extent of the physical risk climate change poses to a firm’s operations. Armed with this knowledge, investors can make more informed decisions about the suitability of an individual investment given their own risk/reward profile.

Jessica will be speaking at Schroders Investment Symposium in 2019.

Find out more at schroders.co.za  

Important Information: For professional investors and advisers only. The material is not suitable for retail clients. We define ‘Professional investors’ as those who have the appropriate expertise and knowledge e.g. asset managers, distributors and financial intermediaries. Schroders Investment Management Ltd is an authorised financial services provider FSP No: 48998, registration number: 01893220