Climate Change Analysis in the Investment Process

Climate change will be one of the most economically impactful events in human history. But currently, our profession is in many cases behind the curve in analyzing the impacts of climate change. This report from CFA Institute includes case studies and survey data to help educate our community and investors about what climate change is and its economic impacts, best practices in analysis, and where to find information for integrating climate change in the investment process.

Estimates of the costs of climate change have a wide range, but they are all bad. A recent report by the Economist Intelligence Unit estimated the net present value costs of climate change at US$4.2 trillion.

The cost of adapting to climate change in developing countries could rise to between $280 and $500 billion per year by 2050, a figure that is four to five times greater than previous estimates, according to a new United Nations Environment Programme (UNEP) report. The Fourth National Climate Assessment published in 2018 by the US Global Change Research Program states, “Without substantial and sustained global mitigation and regional adaptation efforts, climate change is expected to cause growing losses to American infrastructure and property and impede the rate of economic growth over this century.”

Climate change is a force that is already impacting economies and financial markets and, due to the nature of the problem, can be expected to do so with more frequency in the near future. Today, financial professionals have few tools for including climate change metrics in their financial models.

This report focuses on the issue of climate change to help our community and all financial professionals to better integrate climate analysis into their investment process. The report also contains a global survey of CFA Institute participants to gauge their understanding of the issue and includes case studies that can help teach investors how to integrate climate change analysis into the investment process.

As the earth’s atmosphere warms and the side effects of climate change become more prevalent, more pressure will be placed on everyone, including financial professionals, to take actions that address climate change. To do this important work, financial professionals need a few key tools.

• A price on carbon — CFA Institute calls on policymakers to ensure that regulatory frameworks for carbon markets are designed to deliver transparency, liquidity, ease of access for global market participants, and similar standards across jurisdictions, in order to underpin robust and reliable carbon pricing.

• Carbon price expectations included in analyst reports — CFA Institute recommends that investment professionals account for carbon prices and their expectations thereof in climate risk analysis.

• Increased transparency and disclosure on climate metrics — CFA Institute acknowledges that the investment industry is coalescing around the Sustainability Accounting Standards Board (SASB) and Task Force on Climate-related Financial Disclosures (TCFD) standards for climate-related disclosures, which are the most relevant and succinct climate-related disclosure standards for addressing the materiality of climate-related risks.

• Engagement with companies on physical and transition risks of climate change — We believe investors should engage with issuers to ensure that climate data, scenario analysis, and related disclosures are sufficiently thorough to support robust climate risk analysis in the investment process.

• Education within our profession — Investors need to continue to educate themselves about climate change in order to provide clients with the climate-related analysis they deserve.

• Policy that complements our efforts — Investors need to continue to meet with policymakers in order to make sure that investors have the tools they need to do the work of finance — that is, the efficient allocation of capital that helps to tackle the existential threat of climate change.

Investors need to educate themselves on the economics of climate change and understand the implications of a heating world on their investments. As we explore in the next section, this includes understanding the risks as well as opportunities that may arise. To perform this analysis, investors need better data and better reporting standards around climate-related data. They should therefore engage with corporate issuers and policymakers to help inform best practices and standards for climate change–related disclosures.

Investors need to understand how the physical and transition risks brought on by climate change will affect the companies in which they invest. Some of these risks are slowly growing threats, and others have already emerged. Investors should understand the expected intensity or frequency of such risks when possible and engage with companies to understand what strategic steps each company has or has not taken to mitigate these risks. At the same time, the immense changes in society brought about by a climate change transition will present opportunities to investors in both established and nascent industries.

Investors should educate themselves about how carbon markets work in order to better incorporate a likely higher price on carbon into their analysis. Analysts and portfolio managers should run their own scenario analysis to better understand how a carbon price of US$50–US$100/tCO2 in 2030, as recommended by the Stern–Stiglitz Report of the High-Level Commission on Carbon Prices, would affect the companies they analyze or hold in their portfolios. CFA Institute recommends analysts begin factoring expected carbon prices into their financial analysis so they can be prepared for a world with more explicit carbon pricing, whatever form those prices take. See the case study “Carbon as an Emerging Asset Class” for a more in-depth look at the issue of carbon pricing and carbon markets.

Scenario analysis offers investors a tool to imagine a number of different climate change scenarios based on their own research and understanding of the probabilities of certain outcomes. Investors should engage with companies to include more scenario analysis in company disclosures to help investors better understand the possibilities a company faces concerning certain climate-related issues.

Carbon as an Emerging Asset Class
Carbon Cap Management, LLP
Mike Azlen, Alex Child, and Glen Gostlow
Read the case study >
Watch the recorded webinar >

Meaningful Climate Data, Intentional Investments
Mirova
Samantha Stephens
Read the case study >
Watch the recorded webinar >

Assessing the Viability of a Company’s Decarbonisation Plan
Aberdeen Standard Investments
Petra Daroczi

Investing Wisely and Responsibly in Timberland Assets — A Climate-Conscious Case Study
Campbell Global

Climate Change: A New Driving Force for Engagement
UBS Asset Management
Christopher Greenwald and Valeria Piani

Carbon Budgeting in Quantitative Managed Portfolios
Man Numeric
Robert E. Furdak, CFA, and Jeremy Wee, CFA

Physical Risks of Climate Change: Assessing Geography of Exposure in US Residential Mortgage-Backed Securities
Fitch Ratings
David McNeil

Using Climate Considerations to Build Positive Impacts into Fixed-Income Portfolios
Addenda Capital
Brian Minns, CFA, Diane Young, CFA, and Barbara Lambert, CFA

India Equity: Supply Chain Opportunities in a Global Low-Carbon Transition
Manulife Investment Management
Koushik Pal and Eric Nietsch, CFA

APG Approach to Climate Risk and Opportunities
APG Asset Management

Climate Finance: One Foundation's Approach (added 27 September 2021)
William and Flora Hewlett Foundation
Marilyn Waite
Read the case study >
Watch the recorded webinar >

Demystifying Green Bonds (Added 25 October 2021)
Climate Bonds Initiative
Sandeep Bhattacharya
Read the case study >

Integrating Climate Risk Assessment into Private Market Investing (Added 8 November 2021)
Old Mutual Alternative Investments
Dean Alborough
Read the case study >
Watch the recorded webinar >

Sustainable Goals for the Real Estate Sector (Added 29 November 2021)
Afore XXI Banorte
Gabriela Lizette Luna Zambrano, Andrea Ximena Pineda Pérez, and Elda Nohemi Navarro Salas
Read the case study >

Harvest's Approach to Climate Change Risks and Opportunities (Added 13 December 2021)
Harvest Fund Management
Read the case study >