Incorporating climate triggered calamities and disruption in investment strategies

October 11, 2021

Mitigation of climate change triggered investment risks

The physical and transition risks stemming from climate change and the rise in climate-related events and associated investment risks are gaining increasing investor attention globally. Investors approach climate investing in multiple ways. At the basic level, they divest or underweight securities; however, this only shifts the financial risk and is not practical for universal owners. Hence, to improve an investee’s climate resilience or to encourage climate action, investors use their influence and active involvement (engagement/stewardship).

ESG friendly commitments

We see various commitments, such as Net Zero by 2050, that attempt to accelerate this transition. Some investors use more sophisticated techniques to factor in the impacts of sector and business model disruptions caused by regulation and climate-related drivers – for instance, carbon footprinting and scenario modelling. Likewise, various methods are also employed to optimise climate risk in portfolios. For example, carbon-sensitive portfolios target low carbon intensity but have risks, returns and fundamentals similar to the investable universe/benchmark, and carbon diversified portfolios achieve diversification in terms of “carbon sensitivity” and are constructed using forward projections of the Paris Alignment datasets.

The corporate stance

At the corporate level, climate risk strategies vary depending on industry or geographic exposure. For instance, banks pressure corporates to decarbonise and scrutinise customers’ carbon footprints and assess how they align with their public carbon-reduction targets. Insurers assess physical risks to reduce their potential liabilities and account for transition risk to mitigate stranded asset risk. Other sectors too are seeing mounting stakeholder pressure to implement emission-reduction strategies and tighten decarbonisation targets. To fund and enable this transition, corporates use specialised securities such as green bonds and transition bonds, through which investors could get exposure to climate developments. Green bonds pursue financing to fund “green” projects, and transition bonds provide funds to enable a company’s transition to lower environmental impact and carbon emissions.

About the Author

Lead – ESG Research

Qadhir has 12 years of experience in investment research and ESG. He currently leads Acuity’s ESG research delivery franchise and also heads equity research projects in Colombo. Qadhir has overseen the set-up of multiple ESG research engagements with clients based in North America, Europe and Asia, specifically with sell-side and large global asset managers. These engagements cover the spectrum of the ESG research value chain, including ESG scoring and due diligence, SDG analysis, thematic ESG research and ESG stewardship/engagement. Previously, he covered the tech sector for a top-five global investment bank and led a team of analysts that supported a mid-sized European investment bank on multiple sectors, in addition to being a writing analyst of pre-deal IPO research. Qadhir holds a bachelor’s degree in Finance, Accounting and Management from the University of Nottingham.