Why Investors Can't Ignore Climate Change

Reports show investors face mounting risks, especially as new carbon regulations are proposed at the United Nations Climate Change Conference.

As world leaders meet in Paris to discuss climate change, asset managers and consultants are offering guidance on how institutional investors can tackle sustainability—and why it’s so important that they do.

Cambridge Associates and Hermes Investment Management both released reports on how to mitigate climate risk in a portfolio, warning of harm that could come to investments should those risks not be taken seriously.

“Carbon risk cannot and should not be ignored,” said Saker Nusseibeh, Hermes chief executive. “It is time that we in the industry help to address it.”

“Carbon risk cannot and should not be ignored.”

Cambridge Associates reported climate change could directly hurt long-term portfolios through extreme weather events, which could destroy property, or changing weather patterns, which might disrupt supply chains. Additionally, policy and regulatory responses to climate change could impose higher costs on sectors such as fossil fuels, utilities, transportation, and heavy industry.

In particular, Hermes warned the ongoing COP21 conference in Paris will result in new regulations regarding carbon emissions that impose increasing costs on the heaviest emitters.

“Long term, I think carbon risk is a huge issue,” said Gary Greenberg, head of global emerging markets at Hermes.

To manage these risks, both organizations said managers need to be aware of climate risks in their portfolios, and incorporate those risks into investment decisions. Additionally, Cambridge Associates recommended that investors advocate for more transparency and reporting on climate risk metrics.

Other suggestions included proactive hedging via low-carbon strategies and policy-level exclusion of fossil fuel and other sectors. However, the consulting firm said investors should consider opportunity costs before changing asset allocation strategies to protect against risk.

“While carbon regulation and technological advances in alternative energy may be long-term headwinds for traditional fossil fuels, markets are likely to see many more cycles in which investors can capture returns,” wrote Liqian Ma, senior investment director at Cambridge Associates. “Investors should benefit from the flexibility to take advantage of near- to medium-term valuation opportunities, no matter the sector in which these opportunities may arise.”

Rather than just focusing on risks, Cambridge Associates and Hermes both advised investors to consider the opportunities afforded by sustainability. Renewable infrastructure, clean transportation, energy efficiency, and green technology are sectors that will provide structured and regulation-driven growth in the coming years, they said.

“There is too much focus on the risks and not enough on the opportunities,” said James Rutherford, a Hermes fund manager. “If you look just at the risk, there is a danger that you end up excluding companies. If you look at the opportunities for growth, change, and improvement, it is a much more powerful story.”

One such group already planning to take advantage of these opportunities is the newly formed Breakthrough Energy Coalition. The 28-member coalition, led by Microsoft founder Bill Gates and including the University of California, announced at the Paris summit its intention to bankroll investments in clean energy.

“I hope even more governments and investors will join us,” Gates said.

Related: Gates, Dalio, Zuckerberg, U. California Team Up on Clean Energy, Pensions Urge ‘Strong Action’ over Climate Change in Paris, The Multi-Trillion Dollar Impact of Climate Change (and Why ESG Isn’t Enough)