Climate change continues to be a contentious subject, particularly in the US, despite an overwhelming amount of scientific evidence supporting its existence. We’re not here to debate whether climate change is real or not, but it represents an inefficient market where a substantial chunk of the market is factoring in very different information. There are investment opportunities available as a result, but in what markets are there the most impact?
Unfortunately there seems to be little upside in climate change – even the countries that do well in climate change vulnerability rankings are not ranked highly because they benefit, but because they are relatively adaptable to changes. So finding investments most affected by climate change quickly became an exercise in finding investments to avoid, or at least be wary about in a long-term basis. Unfortunately, frontier markets tend to be disproportionately affected due to the absence of infrastructure to combat climate change despite the fact that their emissions are dwarfed by more developed nations.
We look at the risk from climate change as a long-term factor that should be considered a macro risk, similar to demographic factors. So just as investors have long been worried about a rapidly aging population in Japan or China (even if the impact is not entirely obvious or immediate), we believe that investors will begin to be more aware of economic headwinds from climate change in certain countries.
What Impact Has Climate Change Had So Far?
It is worth establishing whether climate change has had an economic impact already. To this we look at the impact of “extreme” weather events, which are one of the easiest ways to quantify the impact from climate change so far. We looked at the Global Climate Risk Index for 2015, published by Germanwatch. They’ve compiled a list of the top 10 countries affected by climate change from 1994-2013: Honduras, Myanmar, Haiti, Nicaragua, Philippines, Bangladesh, Vietnam, Dominican Republic, Guatemala, and Pakistan in that order.
The list is dominated by frontier and emerging market countries. It can also be split into two groups “those that are continuously affected by extreme events and those that only rank high due to exceptional catastrophes”. They listed Honduras and Myanmar as two countries mostly impacted by one-off, black swan like events whereas the other countries routinely face extreme weather.
What was the total impact? According to their study, “more than 530,000 people died worldwide and losses of USD 2.17 trillion (in PPP) were inflicted as a direct result of over 15,000 extreme weather events”. While the economic losses are staggering, we are also of the opinion that the amounts are probably overstated. What tends to happen post most natural disasters is that fresh investment is poured back into the country to help rebuild, which would partially offset economic losses suffered. However, in less developed countries there is no doubt that economic progress is stalled.
What Factors Can Be Used To Quantify Climate Change?
There are three main factors to consider when evaluating a country/market’s exposure to climate change. They are:
- Rising sea levels
- Extreme weather events
- Agricultural productivity loss
These factors are used by many of the rankings and vulnerability indices that we looked at, and are the ones we will be using when considering which investments are most at risk.
What Countries Are Most Vulnerable to Climate Change?
Finding the countries most vulnerable to climate change is an important first step before looking at investments. We looked at data/rankings from S&P, the Center for Global Development, the Notre Dame Global Adaptation Index, and the Climate Vulnerable Forum among others.
Frontier market countries were consistently the worst ranked, particularly those in Asia and Africa. Rather than compile our own aggregated rankings, these are some of the countries that were consistently ranked poorly (in the bottom 30 of rankings):
- Papua New Guinea
- Sri Lanka
We’re looking at almost every EM and FM country in Asia on these lists, with Cambodia, Vietnam and Bangladesh usually cited as the most vulnerable in the world.
What Investments Are Most Vulnerable to Climate Change?
So within those countries, what investments are most vulnerable to climate change?
1. Sovereign Bonds
S&P was the first ratings agency to begin considering climate change into their ratings, citing the material impact to three of its rating criteria: economic, fiscal, and external performance. They ranked every country in terms of its vulnerability to climate change, and consider climate change a “mega-trend” worth factoring into their ratings models. Lower ratings will have a material impact on government bonds in those markets, especially if other agencies like Fitch get in on the action.
2. Real Estate
Real estate is probably the most obvious investment to be wary of in countries most affected by climate change. On the one hand you have extreme weather events that could destroy your property. On the other hand, rising sea levels could also be a factor if your investments are in beach-front, resort properties. Either way, factoring in “Act of God” events into property prices should become more common.
3. Stocks in specific sectors
The overall loss of GDP in climate change vulnerable countries is not directly relevant to the stock market. However, there are several sectors which we would be more cautious in when investing in companies exposed to markets vulnerable to climate change:
- Agricultural companies: agriculture is a sector directly impacted by climate change, especially in countries where technology or hedging instruments are not available to stem unforeseen circumstances
- Insurance companies: if extreme weather events are to increase in number as climate change gets worse, then insurance companies could face huge losses if their policies are not priced correctly.
- Real Estate companies: related to our concerns above in #2, developers in countries most affected by climate change could face increased delays or setbacks when compared with companies operating in more stable environments
- Tourism/Hotel companies: tourism is negatively impacted in countries where extreme weather is a genuine concern when traveling there. Rising sea levels will also become a concern long-term for companies with beachfront property.
Climate change represents an area where we see a big market inefficiency when evaluating investments. It is a factor that we believe is not priced into many investments, but will become more relevant in the future. This list of investments vulnerable to climate change is our initial brainstorm, and we would love to hear your thoughts on other potential ideas below.