How climate change could impact your investments

Glaciers are shrinking, and sea levels are rising. Low-lying communities are getting flooded, while wildfires are ripping through forests. The planet’s climate is changing in dramatic ways, and the scope of the damage isn’t limited to the environment. Extreme weather could pose more risks to your portfolio than you think.

Analysts have already begun to count the cost of global warming to the economy. In April 2022, a U.S. Office of Management and Budget report warned that “floods, drought, wildfires and hurricanes made worse by climate change could cost the U.S. federal government about US$2 trillion each year by the end of this century¹. A Deloitte report indicates that inaction on climate change could cost the U.S. economy $14.5 trillion over the next 50 years².

“Unmitigated climate change would be disastrous for investor portfolios as extreme weather would have an impact across every sector that would be hard to completely avoid,” says Jamie Bonham, Director of Corporate Engagement with NEI Investments Inc., Qtrade Direct InvestingÔ’s affiliate company. “Think of resorts based in low-lying areas that will be prone to rising seas and increased flooding, infrastructure in areas with increased hurricane activity, water-dependent industries in increasingly water-scarce regions.”

The story is similar in Canada. A 2022 report from the Intergovernmental Panel on Climate Change (IPCC), the world’s top climate change research body, outlined Canada’s vulnerability from wildfires, pests and other climate-related factors. The IPCC indicated that climate change costs have been rising in Canada since 1983, and that by 2080, those costs could add up to $459 billion³.

Financial risks of climate change

As the world braces for more extreme weather events, the Bank of Canada has started to take action to address climate change. For the first time ever, in May 2019, the central bank released a report that sheds light on the threats that climate change poses to the country’s financial system⁴. In fact, the bank has listed climate change among the six major vulnerabilities threatening Canada’s economy. One of the biggest challenges facing corporate Canada lies in the transition risks from adapting to a lower-carbon economy.

“This speaks to the risks faced by oil and gas companies, utilities, mining and other high-carbon sectors,” Bonham explains. “Basically, if the world no longer needs the products you produce or if regulations greatly increase your costs, for example through a price on carbon, that is a clear business risk.”

Lower demand, increasing cost of production and regulatory changes are among the climate-related risks which can lead to “stranded assets”—assets which can no longer generate a sufficient economic return. Shareholder value is impaired when these assets are devalued or written off on a company’s balance sheet.

Under the Paris Accord, Canada committed to reducing its greenhouse gas emissions in order to contribute to the goal of limiting global warming to less than 2°C. To honor this commitment, Canada has to shift to a greener economy. In a resource-dependent economy like Canada’s, such a transition will impact many businesses.

“Essentially, any sector that is associated with high CO₂ emissions is at risk. This would include sectors such as the cement and steel industries, which currently have very high carbon footprints due to the inherently high-carbon oriented processes they use to create their products,” Bonham points out.

The insurance sector, in particular, is reeling from the negative effects of climate change. Hit by enormous claims associated with wildfires, floods and hurricanes, insurers are sounding the alarm about the possibility that climate change could make coverage for ordinary people unaffordable. Agriculture and food retail sectors are also vulnerable to climate change.

“A changing climate will have dramatic impacts on the supply chain that brings food to our tables,” Bonham warns. “Some of these costs will be passed on to consumers, but in the case of extreme weather events, it could lead to dramatic losses for industries. Think of losing your entire crop to extreme drought or flooding.”

Opportunities in greener portfolios

Just as extreme weather could drastically change the investment landscape, opportunities could emerge when investors, along with consumers, pivot towards a lower-carbon global economy. As with any emerging sector, it can be challenging to pick the companies that will emerge as leaders. However, companies that find solutions to climate change will attract capital and play a vital role in mitigating the economic impacts.

“There is a desperate need for capital to support the growth of innovation in renewables, energy efficiency, waste recovery, industrial processes and more,” says Bonham.

Joining the sustainability conversation are several oil and gas industry leaders who are exploring how they can fit into a low-carbon transition.

“Some of the players in the oil and gas sector are actively grappling with how to plan for the reality of a lower-carbon economy. That means if you’re committed to positions in the oil and gas sector, it’s possible to back the more progressive firms that are taking a longer-term view,” explains Bonham, adding that opportunities will also arise from investing in solutions that will sustain life.

“Water treatment is a great example. Water availability is going to be a huge issue globally, and it’s going to get much worse in areas that are arid.”

As an investor, one way you can make informed decisions about the security of your investments is to take steps to investigate if the companies you hold have a progressive climate change strategy. You can also seize investment opportunities with companies that are working towards reducing their emissions and finding innovative solutions to lessen climate change impacts. Transitioning to ETFs or funds that have a sustainability theme is one route you can explore.

It’s also important to find out if the companies you invest in are transparent about their impact on climate change. Do they have a credible strategy in place to ensure they’re not actively exacerbating the situation? Have they adopted a climate policy that helps make the transition to a low-carbon future? If you’re buying into investments managed by third parties, make sure the manager is aware of climate change risks and is engaging with the companies in your portfolio to discuss solutions.

If you want to re-imagine your portfolio, you can identify sustainability-oriented investment opportunities. You can discover which companies are leaders in adapting to climate change or investing in solutions by exploring sources such as MSCI ESG indices, Dow Jones Sustainability Indices, Corporate Knights and the Global Sustainability Index. Or check out the Carbon Clean 200, a list of companies working on solutions or advancing innovation for new low-carbon technologies in their industries.

“There’s a path that points to where opportunities are going to come from, and these include companies that implement a thorough transition strategy and work hard to mitigate climate-related risks,” says Bonham.

Interested in learning more about responsible investing?

Visit the NEI website and click on Responsible Investing for articles, whitepapers and other resources.

If you’re ready to incorporate responsible investing into your portfolio, read all about it in Incorporating responsible investing and ESG into your portfolio.