The Impact of Climate Change on Investment Portfolios

First Republic Private Wealth Management
August 31, 2022

  • As efforts to transition to a low-carbon economy accelerate, investors have gained awareness of the climate-related financial risks in their investment portfolios. 
  • While some investors consider this a challenge, investing in more ESG is actually creating new growth opportunities. 
  • Here's what investors should know about the impact of climate change on their investments — and how they can create a nuanced approach to ESG. 

Climate change is the defining challenge of the 21st century, posing a significant threat to worldwide social, political and economic stability. 

Scientists have identified climate change as the driving force behind extreme weather events, which have become more common and unpredictable in recent years. Additionally, climate change has other far-reaching impacts, including the loss of work productivity due to dangerous heat, higher volatility in consumer prices amid supply shocks and rising flood costs for homeowners, businesses, banks and investors. 

Most climatological predictions indicate the Earth’s warming will continue to intensify in the coming decade. As a result, companies will have to evolve in response to new regulatory, environmental and consumer pressures in the coming years or risk losing market share. 

This means investors must adapt, as well. Savvy investors will increasingly turn to ESG (environmental, social and governance) investing to create a portfolio that aligns with their values, as well as to maintain healthy returns while taking steps to minimize climate-related risks to their portfolios.

ESG investing: an opportunity for growth

As devastating as the pandemic has been, it has also opened a window of opportunity for environmentally friendly businesses, as well as those seeking to incorporate ESG into their investment strategy.

The COVID-19 pandemic spurred billions in green stimulus plans worldwide to reinvigorate the economy, which could support industries involved in climate transition through the next decade. In the U.S., the year-end 2020 stimulus bill contained several climate provisions, including $35 billion in spending on clean power sources.

At the same time, the surge in public demand for corporate accountability — especially among younger consumers — encouraged companies across all business sectors to allocate more funds to clean energy investments and decarbonization. 2020 prompted an explosion of “net zero” carbon commitments from companies around the world. It also led to a surge in corporate borrowing to support environmentally friendly initiatives. 

We believe that the sooner companies identify climate-related risks along their value chains, the better equipped they'll be to reduce the possibility of incurring damages from natural disasters, regulatory shifts and liquidity risks as a result of compromised access to capital and finance.

In addition, companies with well-defined, long-term strategies and clear plans to address a broad range of industry-specific climate risks are likely to gain a “sustainability advantage” that benefits investors. They can do this by reducing energy and material costs, increasing competitiveness and enhancing their reputation as leading corporate citizens. 

The risks of climate change for investment portfolios

Just as companies would do well to develop long-term strategies to mitigate the potential risk of climate change, investors should pay attention to climate-related trends that may impact their portfolio.

Two key risks for investors associated with climate change are:

  • Physical risks: Damage stemming from more frequent or severe disasters.

  • Transition risks: Risks related to new policies, reputational impacts and shifts in market preferences and technology. 

The enactment of new legislation could have a considerable impact on the profitability and viability of companies across all industries, leading to large shifts in asset values. Transition risks can also result in some businesses becoming obsolete because of market, regulatory or environmental changes. In short, climate change has clearly become a defining factor in companies’ long-term prospects. 

It is essential that investors implement climate change risk management frameworks that, at minimum, evaluate how both physical and transition risks might affect the value of their investment portfolios. Yet, these assessments should avoid overly simplistic approaches to risk mitigation, such as just refraining from investing in industries that are most exposed to climate change risks or with high carbon footprints. 

A more nuanced approach to risk mitigation

In our view, the new era of global decarbonization will create opportunities for new leaders to rise across all industries, including energy, transportation, manufacturing and agriculture sectors. Investors should assess the complex effects of climate-related trends on multiple industries to evaluate the potential risk to their portfolios. 

For example, while oil companies currently rank higher than other industries in carbon emissions, several players are already taking measures to pivot their businesses toward renewable energy production. By making investments upfront, these companies will benefit from growth opportunities. They will be better positioned to take advantage of emerging trends and develop the products and services that will be on-demand in the future. 

First Republic’s approach to ESG investing

According to several economists, the climate-related shift could be as transformational as the advent of the internet. Therefore, businesses that embrace and lead the change could not only outperform their peers, but also be favored by market participants looking to benefit from the emergence of climate change trends. 

There are several additional steps that investors can take to align their portfolios with ESG principles. At First Republic, we believe that our approach to ESG investing may help clients deploy capital in a way that achieves ESG and financial objectives without sacrificing returns. 

Our overarching, full suite of ESG solutions can not only focus on environmentally-friendly investment vehicles, we believe they can also pioneer a “best in class” approach, through which we aim to invest in high-quality companies with leading track records.

Your wealth manager can help you incorporate ESG investing into your portfolio. For more information, contact your relationship manager and start building a portfolio that aligns with your goals and values. 

This document is for information purposes only and is not intended as an offer or solicitation, or as the basis for any contract to purchase or sell any security, or other instrument, or to enter into or arrange any type of transaction as a consequence of any information contained herein. This information is governed by our Terms and Conditions of Use.