SustainabilityInvestment portfolios may take short-term hits as a result of climate change sentiment

A new report by the University of Cambridge Institute for Sustainability Leadership (CISL) reveals that global investment portfolios could lose up to 45 percent as a consequence of short-term shifts in climate change sentiment.

The report, Unhedgeable Risk: How climate change sentiment impacts investment, concluded that about half of this potential loss could be avoided through portfolio reallocation, while the other half is “unhedgeable,” meaning that investors cannot necessarily protect themselves from losses unless action on climate change is taken at a system level.

“This new research indicates that no investor is immune from the risks posed by climate change, even in the short run,” said Jake Reynolds, director, Sustainable Economy at the Cambridge Institute for Sustainability Leadership. “However, it is surprisingly difficult to distinguish between risks that can be addressed by an individual investor through smart hedging strategies, and ones that are systemic and require much deeper transformations in the economy to deal with. That’s what this report attempts to do.”

Cambridge U notes that while existing studies have analyzed the direct, physical effects of climate change on long-term economic performance, this new report, commissioned by CISL and the Investment Leaders Group, looks at the short-term risks stemming from how investors react to climate-related information, from policy decisions and technology uptake, to market confidence and weather events.

Reynolds continued, “What’s new about this study is its focus on the potential short-term impacts which could surface at any time. Major events, such as the outcome of the upcoming United Nations climate talks in Paris in December, can send signals which drive market sentiment — sometimes slowly, sometimes rapidly — and this study allows us to model the implications.”

The study modelled the impact of three sentiment scenarios on four typical investment portfolios.

The scenarios tested were:

1. Two Degrees, limiting average temperature increase to two degrees Celsius (as recommended by the Intergovernmental Panel on Climate Change [IPCC]) and collectively making relatively good progress towards sustainability, and future socio-economic development goals.

2. Baseline, where past trends continue (that is, the business-as-usual BAU scenario) and where there is no significant change in the willingness of governments to step up actions on climate change.

3. No Mitigation, oriented towards economic growth without any special consideration of environmental challenges, rather the hope that pursuing self-interest will allow adaptive responses to any climate change impacts as they arise.