‘Negative feedback loops’ of climate change a significant risk

By Martha Porado | February 1, 2019 | Last updated on February 1, 2019
5 min read
Rippled nature reflection on pond water surface
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“Climate change is a weapon of mass destruction,” said Sandra Carlisle, head of responsible investment at HSBC Global Asset Management, at a panel hosted by the Responsible Investment Association on Thursday.

It’s critical that investors, who are thinking about how the impacts of climate change present a genuine risk, broaden their perspective to include the multifaceted ripple effects the initial realities of the change are causing, she said.

“Negative feedback loops can come as a result of climate change and do not manifest themselves immediately, but over time.”

One example is climate change’s potentially accelerating effect on involuntary migration, said Carlisle, noting it’s important not to forget about the social cost of climate change in seeking to solve issues on an environmental level.

“It’s now well-documented that the conflict in Syria is in part due to migration internally,” she said. “So worlds of urban displacement of young men, who could no longer pursue a livelihood because of the drying up of the rivers on which they were dependent — that is pretty shocking, when you think about not just that failed state, but also the wider consequences in terms of geopolitics.”

But asset managers shouldn’t take a divestment approach to these issues, said Carlisle. “Once you start excluding and divesting, not only do you create some of these social issues, but also we think it’s sub-optimal in terms of investment return.”

Instead, inclusion and optimization are the way to go to achieve climate-change objectives and carbon reduction in diversified portfolios, she said, rather than passive tilting, replicating or customizing a benchmark.

However, in order to engage properly, investors need a forward-looking, scenario-based approach, said Carlisle, which means coming up with a number of viable solutions and actually testing them to see how they affect returns.

In assessing what scenarios are more likely or even possible, investors must have a critical eye, she noted. “Don’t believe utilities or companies or even governments that tell you they can’t transition.”

In the U.K., she pointed out, there are a number of utility companies that are now exclusively renewables based.

Also, scenario-based thinking won’t necessarily demonstrate risk on a blanket level, said Carlisle. “At the index level, the impact is about two to three per cent. So the skeptics can say, ‘I’m not going to bother.’ But at the sector level . . . impacts are significant.”

While the overall market effects of carbon risk aren’t massive, at a sector level the risk can be extreme and even more so at an individual company level, she added.

“There will be winners and laggards within sectors. So when you think about the investment view, don’t just exclude. It’s really a simplistic way of addressing a big challenge. It seems to be borne out by the work that we’ve done that says, ‘Right now, if you’re looking at 2050, you’re a long-term investor.’ It’s really difficult to work our who the winners and losers are going to be within sectors.

“So stay diversified, stay invested, engage like mad, because we know that will shift companies and improve their behaviour. And don’t make those big bets that will create portfolio distortions,” said Carlisle.

When these risks can be firmly priced, financial markets are going to truly respond, she added. “Capital will flow to those companies that are going to be more resilient. If we back that up with all of the good engagement that I think everyone in this room is doing, then I think we really can drive a transition.”

Even the most entrenched company will give in, over time, to investor pressure, so long as that is rooted in real economic and investor questions, said Carlisle.

She noted, however, that those questions won’t always lead to quantitative answers. “Qualitative information is equally valuable. Not everything that is valuable turns into a number and it isn’t all binary.”

Intangible assets need to be factored in, she stressed. “Markets are good at pricing things. We just have to push harder to say these are real risks.”

Unfortunately, some of the factors the investment industry is basing their scenarios on are no longer really relevant, said Sanjay Khanna, director and futurist at law firm Baker McKenzie, also speaking at the event. He noted the idea of maintaining the rise of global temperatures to two-degrees celsius is no longer necessarily a realistic idea to be modelling projections on. And this illustrates how behind investors are as a whole.

“The number of basic gaps of understanding of how climate risk can play out in the real world, how it could affect equities investments and bonds and all kinds of financial vehicles, is very immature,” said Khanna. “I think that needs to be stated because that’s why the risk is so big and so systemic. That’s why some of you who have children are concerned about what the future is going to be like for them, even in a country as advanced as Canada.”

The risks that seem evident and tangible in day-to-day life shouldn’t suddenly disappear from an investor’s mind when implementing an allocation strategy, he emphasized.

But one serious qualitative risk organizations need to pay more attention to is the effect that climate change has on the mental health of their workforces, said Khanna. “They should take the temperature of the psychosocial stress within their organizations of younger employees around whether climate risk is affecting their anxiety levels.

“That’s data that organizations can understand, and actually pull for and measure by working with [employee assistance program] providers and others. But you have to try to capture risk from as many different angles as you can that reflects some of your interests.”

Also speaking at the event, Laura Zizzo, founder and chief executive officer at business management consultant Mantle314, said there needs to be better education within organizations and businesses about what climate change can actually mean for them.

“They just haven’t been provided with the right information yet. . . . Some of the C-suite that we work with don’t see this as their issue. They say, ‘I would understand if I were an oil and gas company, but as a [real estate investment trust], how is this my issue?’”

There’s currently a major opportunity and appetite for that kind of education, she said, noting it’s simply a matter of making the best use of time before the situation becomes too dire and organizations are justifiably entering panic-mode.

This story was originally published on our sister site, Benefits Canada.

Martha Porado