Unhedgeable risk: How climate change sentiment impacts investment

November 2015 – This report analyses how shifts in market sentiment induced by awareness of future climate risks could impact global financial markets in the short term.

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Context

Climate change may be the 21st century’s biggest threat to humankind, and investors are starting to realise that they’re not immune to the risks. Most existing studies have focused on analysing the direct physical effects of future climate change over the long term (post 2050), then discounted these risks to provide an estimate of their short-term impact.

Unhedgeable risk: How climate change sentiment impacts investment takes a different approach and looks at the short-term risks stemming from how investors react to climate-related information, from policy decisions and technology uptake, to market confidence and weather events.

Anticipating how the market may respond to long-term climate risks attempts to bridge the gap between the geophysical impacts of climate change over the longer term and the potential effects that climate risk may have on the economic and financial markets today.

This study sheds light on the vulnerability and resilience of different portfolio types to climate change-related risks. With this information, investors can start to understand how to hedge risk and invest in assets with lower potential of being affected by climate change risk.

Key findings

• Short-term shifts in market sentiment induced by awareness of future climate risks could lead to economic shocks and losses of up to 45 per cent in an equity investment portfolio value (23 per cent loss for fixed income portfolio).[1]

• Around half (53 per cent) of this decline is “hedgeable” if investments are reallocated effectively, but the other half (47 per cent) is “unhedgeable,” meaning investors and asset owners are exposed unless some system-wide action is taken to address the risks.

• Long-term analysis: Economic growth is highest in the long term if society is dealing successfully with climate change, per the recommendations of the Intergovernmental Panel on Climate Change (IPCC) – with long term annual growth rates of 3.5 per cent.