Climate change - investment risks and opportunities

This summer has been particularly hot in many places around the world, making it hard to turn a cheek to the realities of climate change. Aside from rising temperatures, the climate crisis can also impact your investments in the short and long run. And while it presents risks in some areas, it also provides opportunities in others.

What is climate risk?

When we think of the implications of climate change, we may focus on the environmental impacts it has. But the changing climate can also impact your portfolio. Climate risk is a massive umbrella of investment risk and is typically broken down into two categories- physical risk and transition risk.

• Physical risk is the possibility of natural disasters and other weather events tied to rising temperatures, such as flooding, drought, heat and wildfires, having direct and indirect impacts on facilities, supply chains, employees, customers and more. Some examples of physical risk are:
  • Asset and building damage/destruction
  • Supply chain disruptions
  • Resource and labor availability
  • Insurance liabilities
  • Disruption of food and water supply
• Transition risk is any risk that arises from means put into place to shift from reliance on carbon-based energy toward a low-carbon future. Transition risk includes four subcategories: policy & legal risk, technology risk, reputation risk and market risk. Some examples that are in the scope of transition risk:
  • New climate policies that companies have to adhere to
  • Technologies becoming obsolete as new options with lower emissions come to the market
  • Increased costs of raw materials
  • Changes in consumer preferences

Climate-related opportunities

Fossil fuels such as coal, oil and gas are some of the largest contributors to rising climate temperatures from the greenhouse gases they emit. Scientists say that these emissions need to be reduced by nearly half by 2030 to avoid the worst impacts of climate change, as written by the United Nations.

Although there is much room for improvement to meet this target, countries, companies and individuals are working toward net zero carbon emissions, creating more and more investment opportunities. These climate-related investing opportunities fall under the category of environmental, social and governance (ESG) investments. Here are some to consider:

• Climate adaption solutions including everything from highly efficient air conditioners to floodgates to protect cities that are vulnerable of flooding as sea levels rise to carbon capturing technology.
• Renewable energy investment is critical amid the climate crisis. Renewable energy sources include wind, solar, geothermal, hydropower and biomass. Previously, renewable energy sources were more expensive than traditional ones, but prices have significantly dropped over time. The recent surge in fossil fuel prices will also encourage investments in renewable energy, according to the International Monetary Fund (IMF).
• Electrification of energy consumption in transportation, heating and industrial processes is becoming more popular and helps combat the use of fossil fuels. Think, for example, electric vehicles, charging points, efficient batteries, energy storage technologies and upgrades in power networks.

How to invest with the climate in mind

Aside from the above-mentioned investing opportunities that are arising as economies move toward low-carbon options, below are some more tips on how you can invest with the climate in mind.

Diversify your portfolio

If your portfolio is full of ‘brown’ stocks, companies with high carbon footprints, you can consider adding some sustainable ‘green’ stocks to it. In this case, you are helping to fund environmentally-friendly companies and helping to spread climate risk and diversify your portfolio.

Look into climate-focused ETFs

There are plenty of exchange-traded funds (ETFs) out there that either invest in clean energy companies or track indices that focus on renewable energy.

Do your research

When you think of the biggest pollution culprits, traditional energy companies may come to mind. But companies in other sectors are also a part of the problem. For example, six major banks, including JP Morgan Chase, Citi, Wells Fargo, Bank of America, Morgan Stanley and Goldman Sachs, accounted for 29% of all fossil fuel financing identified in 2021.

It’s, therefore, wise to really look into the companies you are investing in if climate investing is in line with your values or if climate risk is something you take into account when making an investment. One way you can look at a company’s impact on the climate is with ESG scores. On the DEGIRO platform, we offer free ESG ratings from Refinitiv that include over 450 metrics. You can find a company’s overall ESG score, their environmental pillar score, and scores for all the metrics that are taken into consideration, such as emission reduction target percentage and total renewable energy purchased and produced.

Investing with DEGIRO

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The information in this article is not written for advisory purposes, nor does it intend to recommend any investments. Please be aware that facts may have changed since the article was originally written. Investing involves risks. You can lose (a part of) your deposit. We advise you to only invest in financial products that match your knowledge and experience.

Sources: Bloomberg, United Nations, S&P Dow Jones Indices, Diligent, Standard Chartered, Urban Insight, IMF, Russell Investments