Reality check: Climate change is an investment risk

Armando Senra makes the case for viewing a portfolio through a climate lens.


Armando Senra Nov 1, 2021

KEY TAKEAWAYS

  • Recent extreme weather events underscore the growing risks from climate change, including for economies and markets.
  • It is important for investors to consider both the risks and the opportunities related to climate change.
  • Investors can consider building a portfolio with a climate lens through a “reduce, prioritize and target” framework.

This year, and especially this summer, we saw again the impact of climate change. Record high temperatures in the Pacific Northwest. Devastating floods in Europe and elsewhere. An historic drought in the southwest. Massive forest fires in the American West, the smoke of which drifted east and brought hazy, polluted skies to the east coast.  Flooding and destruction from Hurricane Ida, including in the New York area where I live.

One climate-related emergency after another resulted in hundreds of lives lost and countless families uprooted. It has been a human tragedy of immense proportions, and it has been heartbreaking to see.

While climate change is resulting in immense human suffering, the economic impact is also enormous. Insurers may have to pay huge amounts to cover losses, some utilities face billions of dollars in costs to move power lines that can cause fires underground, and companies across a range of industries are dealing with supply chain disruptions.  And this summer was not unique: In 2020, damages from natural disasters cost a record $210 billion, according to Scientific American.1

The events this summer thus reinforces something that we at BlackRock have been saying for some time: Climate change has an economic impact and is therefore also an investment risk.

Climate considerations are key

Climate risk is therefore something that investors should evaluate when building a portfolio for the long term. The impact on insurers, utilities, tech companies and many other sectors can obviously have a significant effect on the bottom line for these companies, and in investors’ portfolios. At the same time, some companies will undoubtedly adapt and thrive. Some will invent or produce cutting edge technologies that will help reduce carbon emissions, while others will successfully transition their business models to a low carbon future.

We believe it is therefore important for investors to consider climate in their portfolios, particularly over the long term to help manage the risks and make the most of the opportunities. Obviously, every investor is different and portfolio construction decisions always depend on the investor’s timeframe, risk tolerance and goals. But with iShares sustainable ETFs, we offer the building blocks and targeted exposures to help construct a portfolio with climate considerations through an approach we call “reduce, prioritize and target."

Chart: Low carbon broad building blocks and targeted exposures

Reduce. A starting point is to consider funds that seek to reduce exposure to carbon emissions or fossil fuels-related activities by metrics related to carbon emissions output relative to sector peers, as well as the level of revenues derived from activities with adverse effects on climate. These funds include a range of regions and asset classes, as well as funds specifically targeting stocks that are less dependent on fossil fuels.

Prioritize.  These strategies take the next step by prioritizing investments based on climate opportunities and risks. In other words, they allocate capital based on a company’s commitments and actions to transition to the low carbon economy, such as companies reducing their reliance on fossil fuels and setting science-based targets.

Target.  Finally, investors can consider focusing on specific industries, themes or asset classes that represent potential opportunities in the transition economy.  My colleagues Jeff Spiegel, Karen Schenone and Sarah Kjellberg recently discussed some of those opportunities, specifically in renewable energy-related stocks and “green bonds”  to help capture the companies and governments at the cutting edge of the transition to a low carbon future. This type of investing may appeal to investors with a higher tolerance for risk, and a longer time investment time horizon.

Planning for the future

Of course, how one blends the reduce, prioritize and target portions of a portfolio depends on one’s own personal circumstances. But one potential way to think about it is to imagine a pyramid, with the “reduce” and "prioritize" sections creating the base, and “target” progressively smaller parts of the total makeup.

Investing with climate in mind is not just about values, but instead reflects the economic and investment realities in a world shaped by climate change. Many companies are preparing for this transition, from automakers who are developing electric or alternative fuel cars to renewable energy firms. Investors who are planning for the future can keep climate in mind as they build their own portfolios – both to help manage the risks and to make the most of the opportunities.

Armando Senra

Armando Senra

Head of iShares Americas at BlackRock