Research

Risks and opportunities of climate change

Climate change presents risks, but there are ways for investors to take part in positive change.

Lily Trager Morgan Stanley Wealth Management’s Director of Impact Investing

As extreme weather events make global headlines and scientists warn about a shifting climate, more investors are thinking about environmental risks and how they might affect their portfolios. After all, global sea levels have risen nearly eight inches since 1880i; NASA satellite imaging indicates that this process is accelerating rapidly,ii threatening major global cities like Shanghai, Osaka, and Miami.iii

But it’s not necessarily all doom and gloom. As someone who creates portfolios that aim to have positive social and environmental impact, I’ve seen that investors can play a role in bringing about change and managing for factors related to climate change can lead to opportunities.

Here are four significant business risks associated with climate change and some ideas for how investors can play a role in mitigating them.

Damage to buildings and operations:

Risk: Physical damage to buildings, supplies and equipment as a result of flooding or other extreme weather events can be costly. These events can also disrupt business by halting manufacturing or making it impossible for employees to get to work.

Opportunity: Companies around the world are preparing for climate change and as a result, they are investing in resilient buildings that can better withstand damage from storms, strong winds and flooding.

Developing countries may offer investment opportunities in new construction and infrastructure projects that are built to hold up under extreme weather events. Investments can include companies that help refit existing buildings and reinforce energy infrastructure for more resilience.

For investors, the opportunities are twofold: energy conservation within existing infrastructure in developed economies, and integration of resource efficiency in new commercial construction in emerging markets. Furthermore, the share of companies in the “green” construction market is expected to grow to 36% from 18% in 2018.iv

Opportunity cost

Risk: Companies that stick with processes and products that are seen as environmentally “dirty” can miss out on new opportunities for growth.

Opportunity: Invest in companies that are on the leading edge of creating products that help the environment and also help other companies get out of “dirty” industries.

This is a fast-growing area. In 2017, Morgan Stanley launched the Climate Change Mitigation Index, which highlights the potential for innovations that mitigate climate change and provide potential market-rate returns. According to information in that report, total investments in renewable energy are estimated to reach $5.1 trillion globally by 2030.

As economies around the world transition to lower carbon economies, investors could benefit from investing in companies that are positioning themselves for this transition and mitigating the effects of climate change.

Consider these facts: Renewable energy sources are now cost competitive in many markets. The cost of utility-scale solar energy declined nearly 30% in the first quarter of 2017 alone,v and by some estimates, the cost of new solar electricity could drop 66% by 2040, and the cost of offshore wind power could drop by 71% over the same period.vi

Reputational risk

Risk: Customers may shun a company that is involved in an environmental or public relations crisis.

Opportunity: Invest in all sectors, but choose companies with the best quantitative and qualitative disclosure and management practices.

One approach is to invest across all sectors of the economy, including traditional energy, but only in companies that have industry leading quantitative and qualitative environmental, social and governance practices. That might mean investing in companies with sound corporate climate policies in place or those that disclose their carbon and water footprints as well as reduction targets over-time.

With regard to the environment, a number of companies have made sustainability pledges, such as achieving carbon neutrality by a certain date, relying more on alternative energy or cutting usage through efficiency.

This also can include companies with better safety records and more diverse boards. By investing in best-in-class companies from an environmental, social and governance perspective, investors may be able to eliminate the worst offenders and position their portfolio in leading sustainable corporate practices across all industries.

Disruption of food and water supply

Risk: A shortage of drinking water or food can affect companies in parts of the world prone to droughts, heat waves or pollution.

Opportunity: Invest in clean farming, water purification systems or evaluate carefully companies with operations tied to parts of the world where food or water could be scarce.

In the primary production sector, heat waves and drought greatly affect agricultural production, including corn, wheat, soy and cotton. Without adaptation, there is a risk that global crop yields could shrink over coming decades.

In developing nations, businesses can suffer when both employees and customers struggle with health issues or need to spend most of their income on basics, like food, rather than participating in the broader economy.

Seizing these opportunities

A financial advisor can help identify opportunities for sustainable impact investments. Another option is an automated investment platform that includes climate solutions to account for some of these environmental risks and opportunities.

It’s not just for the equity side of a portfolio either. Investors can buy bonds of companies with sound environmental policies or choose to buy corporate bonds issued as “green bonds.”

Research from Morgan Stanley finds that the opportunity in green bonds is vast: Approximately $90 trillion will be required in infrastructure investment over the next 15 years to transition to low-carbon economies. Green bonds will be a key financing instrument in achieving this.

Investors who have a goal of achieving positive environmental impact can look to green bonds for an accessible way to invest in low-carbon assets that may to receive a similar return to a regular bond.

As someone who spends a good part of her days researching the influence of climate change on investors’ portfolios as well as the emerging opportunities, I believe that the most important thing is to take action, no matter how small or insignificant it may seem. Climate change poses a complex, systemic global challenge, but its risks can be mitigated and an investment portfolio, no matter the size, can play a role.

For information in investment opportunities across the FinTech and banking sector, please contact your Morgan Stanley Financial Adviser.

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