Investors Can’t Diversify Away from Climate Risk

With the U.S. role in the Paris Climate Agreement hanging in the balance, over 280 investors managing a collective $17 trillion in assets spoke up in support of the agreement:

As long-term institutional investors, we believe that the mitigation of climate change is essential for the safeguarding of our investments. . . . . We urge all nations to stand by their commitments to the agreement.

Why do investors care?  As pointed out in a blog earlier this year, for investors, it all comes down to risk and return. And, where climate change is concerned, this is a risk that is omnipresent.

Simply put, investors cannot diversify away from the risks of climate change. Unlike other risks such as currency fluctuations or new regulations, the disruptive impacts of climate change on the global economic system are so pervasive they cannot be offset by simply shifting stock portfolios from one industry to another.

A study from Cambridge University found equity portfolios face losses of up to 45% from climate shocks, with only half of these losses being “hedgeable.” Likewise, The Economist Intelligence Unit estimates that investors are at risk of losing $4.2 trillion by 2100, with losses accruing across sectors from real estate to telecom and manufacturing.

Because investors recognize that climate risk is unavoidable, they support a coordinated global effort as envisioned in the Paris Agreement. It is also why investors have already expressed such strong support for regulatory limits on carbon and methane emissions.  Governments globally will need to take further proactive action to limit greenhouse gases, and incentivize technology shifts towards lower-carbon energy.

Seizing opportunities in a low-carbon economy

Technology changes will require significant adjustments in how global capital is allocated, which is an opportunity investors are eager to seize because of the promise of risk-adjusted returns in the space.

It is estimated that a shift to a clean-energy economy will require $93 trillion in new investments between 2015 and 2030 and the rise of impact investing shows markets are starting to respond to opportunities in renewable energy, grid modernization, and energy efficiency among others.

For example, the green bond market has grown from $11 billion to $81 billion between 2011 and 2016 with projections for 2017 as high as $150 billion. On top of this, leading global investment banks have already pledged billions towards sustainable investing.

And where capital flows, so do jobs.

As we’re seeing in the US, renewable energy jobs grew at a compound annual growth rate of nearly 6% between 2012 and 2015 and the solar industry is creating jobs 12 times faster than the rest of the economy.  Similarly, the methane mitigation industry is putting Americans and Canadians to work limiting highly potent emissions from oil and gas development.

Technology and capital changes are already happening, but are unlikely to happen quickly enough on their own.  Government policies and frameworks that speed this transition, like a price on carbon, will be critical.

Which brings us back to the importance of the Paris Agreement…

The Paris Agreement is crucial to addressing climate change

Investors vote with their dollars, and are strongly backing U.S. participation in the Paris Agreement. Global investors understand the risk of climate change and see the Paris Agreement as a good return on investment, with an optimistic $17 trillion nod to the power of capital markets to provide the innovation and jobs we need if the right policies are in place. The U.S. administration should ensure it is considering the voice of investors and the capital they stand ready to put to use as it makes its decision.

By Namrita Kapur

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