In practice

Studying how climate change will affect capital markets

Background

Climate science meets investment acumen

In September 2018, we began a collaboration with Woods Hole Research Center (WHRC), the world’s leading independent climate research institute, to study the physical effects of climate change on capital markets and asset prices. Our objective is to develop a series of geospatial maps integrating climate science data with financial data. As part of this project, California Public Employees’ Retirement System (“CalPERS”), the largest US public pension fund, is working with Wellington and WHRC to pilot the application of these investment insights.

I could give 100 more speeches and nothing will change, but if we get 100 security prices to move, something may change.

Phil Duffy, President and Executive Director, Woods Hole Research Center

Approach

Understanding the causes

In many places, more days of extreme heat, longer droughts, or repeated flooding could lead to migration. As people desert intolerable places for more livable ones, asset values will likely fall in the former and rise in the latter. Our goals are to:

  • Understand which companies and regions are actively factoring in climate change
  • Improve our ability to quantify liabilities and appropriately price securities
  • Better assess material business costs and consequences

The scope of our initiative includes the study of six climate variables: heat, drought, wildfires, floods, hurricanes, and water availability. Each of the six variables — and combinations thereof — pose different degrees of risk to different regions and asset types.

Mapping the effects

Our approach, which we call integrated spatial finance, is the visual plotting of capital-market variables over climate variables on a series of global maps. Collaborating with WHRC facilitates our ability to integrate fundamental insights into climate science and enables us to better analyze and question them, and to draw practical, action-oriented conclusions.

High-level summary of our process

  • Determine most relevant metric for the climate variable
  • Create map to highlight change in climate metric by geographic area globally
  • Overlay map with portfolio holdings and relevant holdings characteristics
  • Analyze securities with similar characteristics and pricing but very different climate outcomes
For illustrative purposes only | Sources: Standard & Poor’s, Investortools, Woods Hole Research Center | The projected data presented is hypothetical in nature. No assurance or guarantee is made that any projected data can or will be realized. Actual experience may be outside of stated ranges. All investments are subject to risk of loss.

Results

Linking location to valuation

Insights from our maps are allowing our investors to compare relative valuations and better engage with executive teams. We are encouraging investors to focus on location as a key input into their process. Sectors with significant dependence on fixed locations, such as real estate, mortgages, municipal bonds, insurance, utilities, infrastructure, and agriculture may be the most negatively affected. Sectors with more moveable assets may be better off.

For entities like CalPERS with very long-term liabilities, climate change presents a significant strategic challenge. For society, transparency about climate issues and the repricing of assets can help improve planning for local and federal governments on issues like infrastructure and migration.

Why it matters

We believe capital market participants must manage a variety of risks, including those related to climate change. We hope our work will inspire others to rethink asset class and geographic exposures to better account for physical climate risks. We hope to drive discussions that incentivize longer-term performance measurement to better align climate time horizons with investor time horizons. In our mind, these types of shifts in thinking should be required of forward-looking fiduciaries. They may also help provide better transparency, lead to more gradual asset repricing, and advance and inform public discourse.

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