Weathering the investment risks of climate change

Climate change has become one of the most important themes in the investment world in recent years, following the publication of the Intergov­ernmental Panel on Climate Change (IPCC) 1.5°C report, stressing the importance of lim­iting average temperature rises to 1.5°C to mitigate the impacts of the changing climate.

 

As if to back up the report’s message, there has been a spate of extreme weather events around the world, including wildfires in Australia and California, record temperatures in the Arctic and floods across Europe, Africa and Asia.

 

There has been an enormous cultural shift in investor prefer­ences in sustainability and climate, with asset owners leading the way, says Manuela Sperandeo, EMEA head of sustainable indexing at BlackRock.

 

Climate risk is investment risk

 

“There has been an incredible acceleration in asset allocation preferences towards sustainable options because investors now realise that climate risk is investment risk,” says Sperandeo. “Investors are increasingly asking asset managers to mitigate the effect of climate change on portfolios.”

 

Climate risk is generally split into two categories – physical risk and transition risk. Physical risks directly impact a company’s operations, mainly because of the extreme weather events that are made more frequent and more intense by climate change, such as heatwaves, droughts, floods and wildfires, as well as rising sea levels.

 

Transition risks arise from efforts to deal with climate change, including new laws, tighter regu­lation and evolving consumer preferences for more sustainable products and services, which will create new opportunities and drive innovation.

 

“The way the European Com­mission has defined minimum standards [with its green taxon­omy] has created a level playing field for investors to know what is required. Over time, we believe there will be a repricing effect that rewards portfolios which are cli­mate aware,” Sperandeo says.

 

Making climate investing accessible

 

Exchange Traded Funds (ETFs) will be an important tool in bring­ing climate investing into the mainstream as they are among the most accessible of investment products. For this reason, Black­Rock has created a number of innovative iShares products as part of its mission to expand client choices.

 

The firm now has more than 45 ETFs and index mutual funds built with climate considerations in mind, including a range of funds that align with the objectives of the Paris Agreement. “We also work with our most sophisticated investors to customise their port­folios so that they consider climate change,” Sperandeo says.

 

“Some of our large institutional investors have partnered with us to design new ETF solutions, which could then be scaled across a broad investor audience, ultimately democratising access to the sus­tainability ambitions and insights of some of the most sophisticated and forward-thinking investors in this field.”

 

BlackRock categorises climate investing into three key approaches – Reduce, Prioritise, Target.

 

The Reduce approach seeks to lessen a portfolio’s exposure to the highest carbon emitters. “We now have a more granular insight into how businesses operate and how they are pivoting away from fossil fuels,” Sperandeo explains.

 

Prioritise means investing in target companies looking to make the transition by reducing reliance on fossil fuels, for example, or setting science-based targets.

 

The Target approach includes funds that invest in sustainable activities, such as clean energy, or investments directly tied to projects that advance environmental purposes, such as green bonds.

 

Data-driven approach

 

Data and technology enable BlackRock to measure the climate intensity of portfolios more accurately. “Data is at the heart of what’s happening in sustainable investing,” Sperandeo stresses. “Access to reliable third-party, verified data that allow us to quan­tify the impact of climate change in a more material way for investors is critical to our ability to build solutions which can become the benchmarks of the future.”

 

To strengthen this trend, the firm has been pushing companies to publish more information, especially data that is aligned with the TCFD and SASB frameworks. “The increased volume and stand­ardisation of data will lead to more consistent ESG index construction and allow us to run comparisons across different index providers,” explains Sperandeo.

 

Flows into sustainable investment have tripled from two years ago¹, she adds. “There is an increasing preference for more climate-aware investment solu­tions and BlackRock is committed to helping investors prepare their portfolios for a net-zero world, including capturing opportunities created by the net-zero transition. We have made sustainability a standard pillar across all our product development and investing processes, to help our clients integrate sustainability into their portfolios.”

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¹Source: BlackRock, Global Business Intelligence, as of 28 September 2021

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