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How is Climate Change Affecting the Investment Landscape?

August 18, 2021


The deadly and historic heatwave throughout the U.S. Pacific Northwest in June 2021 was found to be an isolated incident, but one climate experts say was “virtually impossible without human-caused climate change.” It’s one of the latest events to raise alarm about the growing frequency and intensity of natural catastrophes, and it puts increased pressure on determining what steps can and should be taken to help reduce human influence on climate conditions.

A growing number of stakeholders, including governments and regulatory bodies, shareholders, employees and consumers, are starting to hold organizations accountable for their roles in causing or combatting climate change. As a result, climate risk has emerged as a prominent investment issue.

Climate risks include both physical risks, such as storms, drought and flooding, and the transition risks — litigation, reputation, business viability — that develop as governments and consumers embrace the Paris Agreement and move toward “net zero” greenhouse gas emissions.

Globally, regulatory bodies are taking steps to enhance transparency and encourage mitigation activity toward net zero within the next few decades. This increases the pressure on businesses and industries at a time when products, technologies and investor preferences are also changing in the face of climate directives.

“Business leaders should be very deliberate and purposeful in their participation in the transition as we move toward net zero and the Paris Agreement, not only with their own business activities, but as investors of the company’s assets, or investment assets such as retirement plans,” says Russ Ivinjack, global chief investment officer at Aon.

In Depth

Being “deliberate and purposeful” will mean considering both risks and emerging investment opportunities related to climate change and environmental, social and governance issues more broadly.

Investors should have a climate risk strategy, and it should be informed by their shared beliefs around investing in a sustainable, responsible way.”
– Jennifer O’Neill, associate partner, ESG & Responsible Investment at Aon
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“Investors should have a climate risk strategy, and it should be informed by their shared beliefs around investing in a sustainable, responsible way,” says Jennifer O’Neill, associate partner, ESG & Responsible Investment at Aon. “Some of these factors may mean making changes that come at a short-term cost. But ignoring the case for change can mean a risk of underperforming. And that short-term, one-off cost is likely outweighed by beneficial spillover effects as sustainability comes into sharper focus: greater efficiency lowers costs, protects natural capital and manages the effects of ESG trends well, which would otherwise be more costly. Taking action therefore becomes core to fiduciary duty.”

Considering the Risks

The scope of environmental risks in investment portfolios is broad, and mitigation and adaptation activities vary by industry.

“Investors must be concerned with everything from an organization’s carbon footprint, to how that organization interacts with the natural world, including water use and biodiversity, to the impact that climate change mitigation and regulations may have on their ability to do business in the future,” says Meredith Jones, partner and global head of ESG at Aon.

“Climate change risk largely breaks down into corporate and commercial risks. Companies that have high energy use, dependence on fossil fuels, water stress issues and other corporate footprint issues face a different set of concerns than a company that perhaps has an inherently low corporate environmental footprint but has exposure in their business activities. Think of manufacturing or energy versus banks, for example. All have climate change risk, but how they are exposed may look very different,” says Jones.

Jones says that while we have a reasonable handle on the physical risks associated with climate change, it has been harder to grasp transition risk — how climate change affects a business’ ability to continue to operate. Other climate-related risks are emerging too, she says.

“There are reputation issues, litigation issues and questions around ‘Is this product still going to be viable and desirable to consumers?’ All of that is a little more difficult to quantify,” Jones says. “For example, we’re just now starting to see litigation around climate change. We don’t know what that risk is going to look like in three to five years.”

Disclosure Is a Start

To disclose their climate-related risks, many businesses in the U.K. are already using the Task Force on Climate- Related Financial Disclosure (TCFD) framework, though U.S. businesses tend to be at earlier stages of the process. It’s a good start, Jones says, but not a complete solution for assessing or understanding risks.

“Even in the best TCFD disclosures, you still have unknown unknowns,” Jones says. “ESG and climate change are forward-looking risks. You’re depending on the viability of predictive models to understand the full suite of risks and the ways those risks might evolve.”

More Than a Box-Checking Exercise

Considering climate risk in investment decisions calls for a thoughtful approach, Jones says.

“It would be very easy to make this a ‘check the box,’ zero-sum game, where investors might say, for example, ‘We’re just not going to invest in certain types of companies,’ but those decisions can have broader social and community repercussions,” says Jones. “We talk about the ‘transition’ to a green economy for a reason, and while it obviously needs to happen with speed and urgency, minimizing any negative short-term effects should also be a consideration.”

Nearly all capital and financial decisions have broader ripple effects, she notes, and it’s essential that investors playing an active role in the transition to net zero understand those potential impacts.

Seizing the Opportunities

The transition to net zero emissions brings opportunities, too. There’s rising investor interest in renewable energy and infrastructure, and businesses involved in decarbonization — technologies that reduce greenhouse gas emissions resulting from burning fossil fuels.

With buildings responsible for about one-third of carbon emissions worldwide, there can be opportunities to invest in greener, more efficient and sustainable real estate, says O’Neill. But there needs to be careful consideration for location, says Mark Jeavons, principal investment consultant and head of Climate Change Insights and Analytics at Aon. “If you had factories in relatively low-lying areas, for example, they’re going to be at higher risk.”

There have also been innovations in the green sustainability bond area. “We’ve seen a significant uptick in social bonds, as well as sustainability KPI-linked bonds,” says Jones. “That gives investors the opportunity to both do good and do well.”

The capacity of such investment vehicles isn’t yet adequate to meet demand, but it’s growing. And major investment firms are now creating funds with sustainable investment options.

Ultimately, investors need to be selective and conscious of asset valuations as they seek pockets of value in opportunities related to addressing climate change, Jeavons says. “It’s a bit like the gold rush,” he says. “You want to invest in the companies that are selling buckets and spades — not the companies looking for gold. When looking for climate opportunities, you want to be focused on those companies delivering proven solutions that are needed to support the transition to a low-carbon economy.”

A “Culture of Sustainability”

As our understanding of climate risks continues to evolve, investors should be prepared to adapt — and adopt a new mindset about these complex and evolving issues.

Ivinjack says both corporate and investment C-suite leaders need to “rewire the decision-making process” to adequately address climate risk.

Instead of compartmentalizing investments, cast a broader net. Evaluate and compare across manager categories. Look for strategies that will have this positive impact and figure out how it fits into your total portfolio.”
– Russ Ivinjack, global chief investment officer at Aon
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“Instead of compartmentalizing investments, cast a broader net. Evaluate and compare across manager categories. Look for strategies that will have this positive impact and figure out how it fits into your total portfolio,” he says.

Jones says there are lessons from the past we can apply here.

“Over a decade ago in the investment industry, we started talking about the need for a ‘culture of compliance’ so organizations could mitigate their operational risks,” says Jones. “This is the same thing. We need to develop a ‘culture of sustainability’ in our organizations. That’s the only way that you’re going to be able to identify and mitigate these risks in real time.”

Learn more about Aon’s commitments to environmental, social and governance issues — including the new Aon Global Impact Investment Fund — in the 2020 Aon Impact Report.

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The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Information contained herein is for informational purposes only and should not be considered investment advice.

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