16 February 2011

What Does Climate Change Mean for Investment Portfolio Risk?

Mercer, a global financial services firm, has just issued a major new report on the risks of climate change on investment portfolios.  The report was produced with the help of the LSE Grantham Institute and the World Bank.

A Reuters news story on the report says the following:
Climate change could put trillions of investment dollars at risk over the next 20 years, a global study released on Wednesday said, calling for pension funds and other investors to overhaul how they allocate funds.
However, when you actually take a look at the report, you find that it does not say what Reuters (or others) says it does .  The report presents several top line conclusions about portfolio risks over the next 20 years.

First, climate policies might have a large financial impact on portfolio risk:
[C]limate policy could contribute as much as 10% to overall portfolio risk: Uncertainty around climate policy is a significant source of portfolio risk for institutional investors to manage over the next 20 years. The economic cost of climate policy for the market to absorb is estimated to amount to as much as approximately $8 trillion cumulatively, by 2030. Additional investment in technology is estimated to increase portfolio risk for a representative portfolio by about 1%, although global investment could accumulate to $4 trillion by 2030, which is expected to be beneficial for many institutional portfolios.
Second, what about the risks caused by actual changes in the climate? (emphasis added)
The economic model used in this study excludes physical risks of climate change which are not consistently predicted by the range of scientific models, and primarily for this reason concludes that, over the next 20 years, the physical impact of changes to the climate are not likely to affect portfolio risk significantly. However, this does not imply the absence of significant (and growing) risk, as shown by recent climate-related disasters that investors need to monitor closely.
Thus, the risk to financial portfolios in the report is entirely due to climate policies and not the effects of "the physical impact of changes to the climate."  Of course, a news story that begins -- "Climate change policies could put trillions of investment dollars at risk" -- doesn't really have the same ring to it.