2030 Finance | August 24, 2015

Climate Exposure: Reading the Signals for Investment Risks and Returns

The team at


There’s a term emerging for the investment risks and opportunities ushered in by a changing climate: climate exposure.

new report from the Climate Policy Initiative, a nonprofit thinktank founded in 2009 with support from financier George Soros, and Stanford’s Steyer-Taylor Center for Energy Policy and Finance, backed by California billionaire Tom Steyer, surveys the landscape of tools and products for managing climate exposure and finds they continue to leave investors open to unaddressed financial risks.

Perhaps even more significantly, the current tools undervalue the long-term opportunities for mitigating and adapting to climate change. That is hampering the allocation of capital to finance the transition to the low-carbon future, and causing many investors to miss the many opportunities to participate in the green economy.

Such imperfect information, of course, opens opportunities for ‘alpha’ investors to get ahead of the crowd, or at least better mitigate their own portfolio risks.

screenshot 5The report offers a framework for minimizing “brown” capital and maximizing “green” capital. That requires management of the three broad types of exposure: policy and legal exposure (e.g., carbon pricing schemes), physical and ecological exposure (e.g. financial impacts of hotter weather on agricultural yields), and market and economic exposure (e.g. growth in clean tech industries).

An ideal framework for managing climate exposure involves both assessing and minimizing climate risk from traditional high-carbon, or “brown,” investments exposed to policy, physical, and economic risks, while also pursuing climate-related opportunities through investments aimed at mitigating climate change (renewable energy, energy efficiency, carbon capture and sequestration, etc.) or aimed at adapting to it (infrastructure improvements, agricultural engineering, etc.).

Climate-related factors such as erratic weather patterns, new government policies, and changing human behavior all have financial implications for investment portfolios. A full assessment of such exposure would include factors such as the compliance costs associated with new climate mitigation and adaptation laws, higher energy prices due to carbon pricing, and stranded assets from policy and energy-related price shifts (e.g. coal mines becoming impractical for development due to a new carbon pricing regime).

Agriculture and commodity price fluctuations due to weather changes and resource scarcity hits, for example, beverage companies dependent on water supplies. Commodity prices and resource scarcity hit supply chains. Infrastructure is vulnerable to severe weather and sea rise.

Managing Climate Exposure

The main obstacle to effective management of portfolio exposure to climate change is a misaligned time horizon. Many investors and stakeholders interviewed by CPI said the longest period over which the typical investor manages risk is three to five years. But many climate-related risks will emerge over decades.

Other investors cited a lack of uniform metrics, lack of understanding of alternative types of climate exposure investments such as ESG (for environmental, social, and governance) data-driven indexes and green bonds. Parsing which emerging “green” investments significantly contribute to climate change mitigation or adaptation remains difficult.

The report notes the substantial research that suggests that investments (companies and funds) with strong performance across ESG metrics have better long-term performance than their low-performing peers. But ESG data remains skewed toward management of portfolio risk rather than assessing pro-carbon investments such as renewable energy and agricultural resiliency. (For more on ESG data, tools, and methods of analysis, read section three (pg. 5) of the report.)

The report outlines a range of climate-exposure strategies, all imperfect:

Exclusionary indexes, such as Fossil Free Indexes US (FFIUS)draw from socially responsible investing and the divestment movement, excluding companies and sectors seen as ethically fraught. In the context of climate exposure this means the exclusion of fossil fuel companies.

Ethically and politically pleasing, exclusionary indexes, divestments have little direct financial effect on oil companies.

Non-exclusionary indexes, such as the SPDR MSCI ACWI Low Carbon Target Index, target cleaner, more sustainably managed companies across sectors. Largely based on ESG scores, such indexes may reward companies that manage climate exposure better.” These types of indexes also can help investors manage downstream and supply chain climate exposure.

Thematic “green” indexes, such as The MSCI Global Climate Index, include companies operating in renewable energy, clean technology and efficiency, future fuels and other “green” sectors. The companies are often deemed leaders in climate change mitigation though, the reports notes, the criteria are often broad leaving  how “green” such indexes are open to interpretation.

Green bonds, such as those included in the Calvert Green Bond Fund, are fixed-income securities in which the proceeds of the bond are linked to “green” activities. Issues of green bonds skyrocketed to nearly $40 billion in 2014, up from $15 billion in 2013. But no definition of  “green” has been universally accepted, and only 61 percent (by value) of bonds in 2013 and 2014 were issued with an independent review of  their “green” label. “Because of this information gap, it can be hard for investors to use green bonds, either to minimize existing climate risk or to pursue outperformance strategically.”

Yieldcos are publicly traded spin-offs of energy companies that hold long-term, predictable, yield-oriented assets like completed renewable energy projects and infrastructure. The yieldco market has grown to a $20 billion market in the last few years. Yieldcos open up renewable, liquid energy investments to investors with “green” mandates but have not yet attracted institutional capital on a large scale.