Asset managers that incorporate climate change into their investment processes are increasingly looking beyond commitments to net zero and exploring the impact on asset valuation, said Michelle Dunstan, chief responsibility officer at AllianceBernstein, during a session at the Canadian Investment Review‘s 2021 Investment Innovation Conference.
“A changing climate can be described both in terms of means and extremes. Averages will change and extreme events will become more frequent and more severe. Today’s society is organized around an historic understanding of those means and extremes. Where we live, how we live, what we produce and how we produce it — a changing climate will affect how society’s organized and, in turn, affect cash flows and asset prices.”
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To do that more effectively, Dunstan said managers need to expand their analysis beyond the first and second order impacts tied to historic norms and patterns. She cited the 2010 global wheat shortage — caused by separate extreme weather events in Australia, Canada, China, Ukraine and Russia — which she argued led to the Arab Spring of 2011 and related fluctuations in oil prices.
“The largest wheat importers are in the Middle East, where food represents a large portion of household spending and much of these food calories come from bread. . . . Climate change didn’t cause [the Arab Spring], but it acted as a powerful accelerant. And instability in the Middle East has profound implications for the oil market — there’s actual supply constraints and the fear of unrest leading to further constraints driving up prices. It also led to the U.S. and Canadian shale revolutions, which generated economic return and ramped up quickly, lowered the cost [of this oil production method] and became a permanent fixture of the oil market.”
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In determining the impact of climate change on an asset’s value, managers will need to consider the effect on macroeconomic factors — such as interest rates and inflation — while thinking broadly across disciplines, said Dunstan. “[Managers] need to develop knowledge of climate science as well as geography, political science and agriculture. At a macro level, global economic growth will be slower — GDP is labour force times productivity and climate change will slow both. . . . Current productive capital could be stranded or lost [and] inflation and interest rates will also likely be higher.”
She also urged investors to analyze risks and opportunities at an issuer level — such as damage and loss from sea level rise and increased costs due to greener technology requirements — by following the carbon, said Dunstan. “[These risks] are easy to understand, but hyper local. Investors need to understand on an issuer basis where all of their assets are, as well as their supply chain and customer base. You need to evaluate physical and transition risk and the opportunities of a particular issuer and the impact on each of the impact statements, the balance sheet and the cash-flow statement. . . . These are risks that are materializing today.”
Read more coverage of the 2021 Investment Innovation Conference.