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Climate Change and Investment Analysis

24th October, 2013 · Tom Brakke, CFA
Tom Brakke, CFA

When readers of the print edition of Bloomberg Markets received the November issue, they were confronted by bold letters on a red background that proclaimed, “The Risks Heat Up.”  A light blue circle provided visual contrast and more context: “Special Report:  Climate Change.”

The four items in the issue included a feature story (the subhead for which began, “As the risks grow on a hotter planet . . .”); a sidebar on how rising seas have affected agriculture in Vietnam; a look at the “laboratory” that is Alaska; and a graphic of the threats and opportunities around the world as a result of climate change.

Bring up climate change and you are sure to get immediate reactions from those on one side of the debate or another, although this is an issue where the political lines aren’t always predictable.  For analysts, however, the question should not be a political one, but a research-based one, dependent upon the facts to date, the scientific possibilities, scenario analyses, and educated estimates of probabilities.

Like it is with other investment endeavors, time horizon is very important here.  As a society, we should be considering the potential long-term impact of climate change and making the appropriate policy changes on that basis.  As investors, that societal horizon might seem too long for our purposes, the impacts too far away to be relevant.  But at some point, our analytical methods may need to be adjusted based upon the range of possible climate outcomes.  (Disclosure:  I wrote a piece on warming up the models of investment analysis in 2008.)

The magazine’s feature leads off with Tom Steyer (the founder of Farallon Capital Management) reflecting on his discussions with other investment and business leaders about what Bloomberg describes as “the biggest game changer of all.”  He says, “We need to get rid of this idea that going with the status quo is a smart economic thing.”

But there are entrenched parties on all sides, some of whom argue for the continuation of current policies and “adaptation rather than mitigation” should there be bad climate outcomes ahead.  And the prospects aren’t all bad; change doesn’t just bring risks, it also brings opportunities.  There are winners and there are losers.  Assessing which is which could be the great investment opportunity of the next few decades.

Already we’ve seen substantial changes in farming from new climate patterns and “more violent weather,” but new sea lanes have also opened up from the planet’s warming.  At the margin, industries are changing in response to the climate.  To what extent are investment analysts adjusting as well?

While it was not featured in the stories, the insurance industry is at the forefront in considering the economic effects of climate change, which makes sense given that it deals with long time horizons and potential risks.  But shouldn’t all of us be thinking about the prospects given the enormous potential impact on companies, industries, and markets?

As Nicholas Stern, the head of Jeremy Grantham’s institute on the effects of climate change, said, “This is a staggering creation of risk, and an analysis of this risk is fundamental.”

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