Is climate change scorching investment portfolios?

Measuring impact of wildfire risks and climate change-related events remains challenging, says sustainability-focused PM

Is climate change scorching investment portfolios?

Climate change is making itself felt across the world through extreme highs in temperature and historic calamities. But determining how it flows through into investment portfolios – and mitigating the attendant risks – remains a challenge, according to one portfolio manager.

“While change-related impacts are being felt now, the financial sector has tended to view it as a long-term risk,” says Martin Grosskopf, VP and portfolio manager at AGF Investments, who manages the firm’s sustainable investing strategies. “This mismatch makes it very difficult to protect against.”

As the world burns

As Grosskopf notes, the physical risk aspect of climate change is being felt most acutely through the insurance industry. Speaking to a US senate committee earlier this year, Aon PLC President Eric Andersen sounded the alarm on growing climate change-driven uncertainty in the insurance industry, whose foundation of risk prediction is growing shakier amid “a crisis of confidence around the ability to predict loss.”

He reported that reinsurance companies, which help insurers pay out catastrophic losses, “have been withdrawing from high-risk areas, around wildfire and flood in particular.” Drawing a parallel to the Great Financial Crisis, he added: “Just as the U.S. economy was overexposed to mortgage risk in 2008, the economy today is over exposed to climate risk.”

In an interview with BNN Bloomberg, Craig Stewart, the Insurance Bureau of Canada’s vice president of Climate Change and Federal Issues, said insured loss payouts have risen approximately five-fold over the last 15 years, reaching $3.4 billion last year. Those losses, he said, capture a myriad of extreme climate change-related calamities that include intense flooding, wildfires and hailstorms, among others.

Outside the insurance industry, Grosskopf says investment portfolios can suffer direct impacts from assets being lost or impaired due to climate change. While insurers are bearing the near-term risks, he says those in the forestry industry are also getting an immediate shock to their systems. 

“In reality, these direct impacts are minimal today for most diversified portfolios,” Grosskopf notes. “The challenge will be gleaning impacts that become repetitive as opposed to episodic.”

A dilemma for risk management

Like any problem under the broader category of systemic issues, he says climate change poses a risk-management challenge for portfolio managers because of its complexity.

The record-setting wildfires that have raged across the Great White North of late – including an inferno that prompted an evacuation of Yellowknife, the capital city of the Northwest Territories, last Thursday – might be regarded by some as an extreme extension of an annual trend of May-to-September flareups.

But this past summer has produced a host of black swan calamities and emergencies, including the Maui wildfire, the deadliest in the US in the last century. Whole cities and regions have also struggled through extreme, occasionally unbearable and life-threatening heat levels in the past few months.

A parade of research findings has confirmed historically high temperatures last month, including NASA, which logged the hottest July in records going back to 1880.

“There are physical modelling programs available at the asset level [to help assess systemic climate risks], but these are generally too granular for most portfolio managers,” Grosskopf says. “We know where assets are most likely to be at risk, but estimating the probability of an event is very difficult unless they become recurrent.”

Against a backdrop of catastrophes and escalating climate risk, Grosskopf is looking to help make a difference through his investments. In his portfolio, he allocates toward areas where companies are working on answers to the climate change challenge. Stantec and WSP, he says, stand out as companies that conduct planning studies and design physical adaptations against climate risk.

“My approach is to seek firms with opportunities related to these complex sustainability issues,” he says. “This inherently means adopting a longer-term focus as we know climate change will become more visible over time - creating significant demands for solutions.”