Preparing portfolios for the climate change index

Marie-Helene Royet

The world is currently witnessing a series of extreme weather events, from heat waves to wildfires including devastating floods. In addition to the tragic loss of life, it is now vital to understand the economic impacts of these disasters.

Long-term investors need to rethink their asset valuation models, often obsolete. Climate risks encompass the planning and effectiveness of climate policies, the extent of physical risks, as well the potential impact of future climatic factors on certain industries and businesses. The combination of these factors can lead to greater frequency of unpredictable market shocks. – reports Monaco for Finance.

As can be seen by the continued uninsured losses arising from natural disasters, the impact of climate change on economies and businesses is still largely underestimated by economic actors. These risks are no longer limited to the confines of “remote” countries; natural hazards now affect all developed countries. According to estimates by insurance companies, over the last five years, flood-related losses worldwide have amounted to US$300 billion, of which only US$45 billion was insured. The costliest flood-related disaster in history occurred in July 2021 in Central Europe when devastating floods in West Germany saw overall losses in excess of EUR 45 billion.

To prepare portfolios for the impact of climate change, investors need to pay more attention to countries, industries and businesses that demonstrate resilience, long-term planning and adaptability to not only survive, but also thrive, as global temperatures continue to rise.

Agriculture, one of the most vulnerable sectors, accounting for about 70% of the world’s freshwater consumption, is a perfect example of this reality. A report by Morgan Stanley estimates that a significant proportion of world crops such as wheat (44%), rice (43%), corn (32%) and soybeans (17%) come from high-risk areas. Climate-related disasters could undermine annual production valued at hundreds of billions of dollars and threaten economic growth in many countries. As an investor, it is essential not only to take these climate risks into account when assessing commodity prices and the ratings of certain sovereign debts, but also to prioritise smart and innovative businesses. This will reduce portfolios’ volatility and thus their overall risk over time.

There is growing interest from policy-makers and investors in plant sciences and innovations that can mitigate the impact of future water shortages. European countries, which until now have been sceptical, are now opening up to genetically modified varieties designed to withstand extreme weather conditions and drought. A notable example is Bayer, which developed a corn variety that requires less water. Gradient, a Boston-based company that pioneered the development of new industrial wastewater treatment methods, has become the first start-up specialising in water technologies to reach a valuation of $1 billion this year. Although costs remain high and efficiency is still limited, the desalination market is expected to grow sharply in the coming years.

The industry itself is vulnerable to water shortages, with Moody’s estimating that nearly half of the world’s chemical assets are exposed to water stress. In Germany, the industry’s use of the Rhine for cooling and transport has repeatedly been compromised by droughts. In 2018, the chemical giant BASF saw its profit drop by EUR 250 million due to low water levels. According to Moody’s, about one fifth of all electronics factories in Asia are located in flood-prone areas. Preventive measures do mitigate risk and it is imperative that investors integrate these approaches into their valuation models. For example, TSMC, the world’s largest chip manufacturer, raised the foundations of its new plants in Taiwan by two metres.

It is also crucial to note that the impact of climate change is not the same across the world and in fact creates opportunities for certain geographical areas. For example, vineyards are growing in countries such as the United Kingdom and Denmark.

Investors have begun to assess the colossal financial burden of decarbonisation. However, it would be far riskier to minimise the even greater costs that would be incurred through inaction.

As financial markets and the global economy enter a sustainable era of climate policy implementation, we are bound to witness periods of volatility associated with this energy transition. For investors seeking to mitigate climate risks and support forward-looking solutions, it is therefore important not to be distracted by short-term “noise” and to maintain a mindset geared to longterm climate solutions.

Source: Monaco for Finance

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