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Climate change - investment risks and opportunities

Climate change has become an undeniable reality, with soaring temperatures becoming the new norm in many parts of the world. Aside from rising temperatures, the climate crisis can also impact your investments in the short and long run. And while it presents risks in some areas, it also provides opportunities in others.

With growing concerns about climate change and the depletion of traditional energy sources, finding sustainable alternatives has become an urgent priority. Clean energy, which includes renewable sources such as solar, wind, hydro and geothermal power, offers a promising solution for meeting our energy needs while minimising our impact on the environment.

What is climate investing?

Climate investing is the practice of investing in companies, projects or initiatives that aim to reduce greenhouse gas emissions, adapt to climate change impacts or promote sustainable practices. In short, climate investing focuses on supporting activities that mitigate climate change risks and drive positive environmental outcomes. It goes beyond traditional investment strategies by considering both financial performance and environmental impact.

Climate investing plays a crucial role in addressing the urgent need for environmental action. By directing resources towards companies committed to reducing their carbon footprint or developing clean technologies, investors can accelerate the transition to a low-carbon economy. On top of contributing to a more sustainable future, climate investing offers potential financial benefits. As governments around the world implement stricter regulations and consumers increasingly demand greener products and services, companies embracing sustainability are likely to see growth opportunities and competitive advantages over time.

What is climate risk?

When we think of the implications of climate change, we may focus on the environmental impacts it has. But the changing climate can also impact your portfolio. Climate risk is a massive umbrella of investment risk and is typically broken down into two categories- physical risk and transition risk.

  • Physical risk is the possibility of natural disasters and other weather events tied to rising temperatures, such as flooding, drought, heat and wildfires, having direct and indirect impacts on facilities, supply chains, employees, customers and more. Some examples of physical risk are:
    • Asset and building damage/destruction
    • Supply chain disruptions
    • Resource and labor availability
    • Insurance liabilities
    • Disruption of food and water supply
  • Transition risk is any risk that arises from means put into place to shift from reliance on carbon-based energy toward a low-carbon future. Transition risk includes four subcategories: policy & legal risk, technology risk, reputation risk and market risk. Some examples that are in the scope of transition risk:
    • New climate policies that companies have to adhere to
    • Technologies becoming obsolete as new options with lower emissions come to the market
    • Increased costs of raw materials
    • Changes in consumer preferences

Trends in climate change investing

Climate change has become a global concern and is driving significant changes in investment strategies. In recent years, investors have increasingly incorporated sustainability factors into their decision-making processes. Here’s a closer look of trends that have emerged:

  • ESG: Some investors are recognising the importance of integrating environmental, social and governance (ESG) factors into their investment decisions. ESG considerations evaluate a company's environmental impact, social responsibility practices and corporate governance structure. With these factors in mind, investors can identify companies that are actively addressing climate-related risks and opportunities.
  • Impact investing: Impact investments aim to address specific sustainability challenges by allocating capital to projects or companies that create measurable positive impacts. Green bonds have emerged as an essential instrument within impact investing. These bonds raise funds for projects focused on renewable energy, energy efficiency, sustainable infrastructure development and other environmentally friendly initiatives.
  • Demand for climate-related data: Investors are demanding more transparent and reliable climate-related data from companies. They now expect companies to disclose their carbon emissions, climate risk assessments and strategies for transitioning to a low-carbon economy. Access to comprehensive and standardised data could make it easier to assess a company's exposure to climate risks and make informed investment decisions.

Climate related opportunities

Fossil fuels, such as coal, oil and gas, are some of the largest contributors to rising climate temperatures from the greenhouse gases they emit. Scientists say that these emissions need to be reduced by nearly half by 2030 to avoid the worst impacts of climate change, as written by the United Nations.

Although there is much room for improvement to meet this target, countries, companies and individuals are working toward net zero carbon emissions, creating more and more investment opportunities. Here are some to consider:

  • Climate adaption solutions including everything from highly efficient air conditioners to floodgates to protect cities that are vulnerable to flooding as sea levels rise to carbon capturing technology.
  • Renewable energy investment is critical amid the climate crisis. Renewable energy sources include wind, solar, geothermal, hydropower and biomass. Previously, renewable energy sources were more expensive than traditional ones, but prices have significantly dropped over time. The recent surge in fossil fuel prices will also encourage investments in renewable energy, according to the International Monetary Fund (IMF).
  • Electrification of energy consumption in transportation, heating and industrial processes is becoming more popular and helps combat the use of fossil fuels. Think, for example, electric vehicles, charging points, efficient batteries, energy storage technologies and upgrades in power networks.

What is greenwashing?

You may have heard the term 'greenwashing' when talking about climate change and climate investing. This term refers to the deceptive marketing and promotion of products or services as being environmentally friendly, when in reality they may have little or no positive impact on our planet.

Greenwashing tactics are designed to mislead consumers and investors who want to make responsible choices for the environment. Companies may use various strategies such as vague or misleading language, exaggerated claims or even false certifications to create a fake idea of sustainability. The intention behind greenwashing is generally driven by profit rather than genuine environmental concern. For investors committed to making ethical decisions about climate investments, falling victim to greenwashing can have serious consequences. Allocating funds to companies that misrepresent their environmental impact not only undermines the effectiveness of climate investing, but also compromises the investor's goals and values. To protect yourself from this, it’s good to do your research on the companies you want to invest in, use reputable sources or independent rating agencies to check a company's environmental performance and think about diversifying your investments across a range of industries and sectors involved in sustainable practices.

How to invest with the climate in mind

Aside from the above-mentioned investing opportunities that are arising as economies move toward low-carbon options, below are some more tips on how you can invest with the climate in mind.

Diversify your portfolio

If your portfolio is full of ‘brown’ stocks, companies with high carbon footprints, you can consider adding some sustainable ‘green’ stocks to it. In this case, you are funding environmentally-friendly companies, spreading climate risk and diversifying your portfolio.

Look into climate-focused ETFs

There are plenty of ETFs out there that either invest in clean energy companies or track indices that focus on renewable energy. We even have some included in our Core Selection , such as iShares Global Clean Energy UCITS ETF (IE00B1XNHC34) and Lyxor New Energy UCITS ETF (FR0010524777). For these, you only pay a €1 handling fee and no commission fees*.

* The ETF Core Selection is subject to change and falls under a Fair Use Policy. If the conditions of the Fair Use Policy are not (or no longer) met, an additional commission fee of € 2.00 applies to any trade in an ETF of the Core Selection. Consult the ETF Core Selection List and Fair Use Policy before you trade.

Do your research

It’s wise to really look into the companies you are investing in if climate investing is in line with your values or if climate risk is something you take into account when making an investment. One way you can look at a company’s impact on the climate is with ESG scores. On our platform, we offer free ESG ratings from LSEG Data & Analytics that include over 450 metrics. You can find a company’s overall ESG score, their environmental pillar score, and scores for all the metrics that are taken into consideration, such as emission reduction target percentage and total renewable energy purchased and produced.

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The information in this article is not written for advisory purposes, nor does it intend to recommend any investments. Please be aware that facts may have changed since the article was originally written. Investing involves risks (e.g price volatility, currency or liquidity risk). You can lose your invested funds. Consider your knowledge and experience when making investment decisions. Past performance is not a reliable indicator of future results. Markets are volatile and can fluctuate significantly due to economic, political, regulatory, or other developments.

Sources: Bloomberg, United Nations, S&P Dow Jones Indices, Diligent, Standard Chartered, Urban Insight, IMF, Russell Investments

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Investing involves risks. You can lose (a part of) your invested funds. We advise you to only invest in financial products which match your knowledge and experience. This is not investment advice.

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