Market Perspectives May 2024
As pessimism sets in on the pace of rate cuts, find out our latest views on global themes, trends and events influencing investors.
Investing Sustainably
Making portfolios more weather resistant
03 May 2024
Damian Payiatakis, London UK, Head of Sustainable & Impact Investing
Please note: This article is designed to be thought leadership content, to offer big picture views and analysis of interesting issues and trends that matter to our clients and the world in which we live. It is not designed to be taken as expert advice, investment advice or a recommendation, and any reference to specific companies is therefore not an opinion as to their present or future value or broader ESG credentials.
Reliance upon any of the information in this article is at the sole discretion of the reader. Some of the views and issues discussed in this article may derive from third-party research or data which is relied upon by Barclays Private Bank and may not have been validated. Such research and data are made available as additional information for the reader where appropriate.
Key Points
- With global temperatures reaching new highs and climate change impacts intensifying – investors are now asking: “How resilient are our portfolios to the potential financial fallout from climate change?”
- Droughts, storms and rising sea levels – these physical risks pose diverse and significant threats to businesses. For instance, operating costs could soar, or weaker demand and production capacity could cause revenues to decline
- By assessing these physical climate risks, investors can strengthen their portfolios against the challenges of changing weather patterns, while also making the most of opportunities arising from the transition to a low-carbon economy
- By actively addressing physical climate risks from shifting weather patterns, investors can build a stronger defence against the financial threats of climate change – don't underestimate the power of proactive preparation today to safeguard your financial future
Average global temperatures are rising faster than expected, with March the tenth consecutive hottest month on record1. The physical impacts of climate change are being felt sooner and more substantially than many scientists imagined2. For investors, perhaps the question should be “How prepared is my portfolio for potential financial fallout of climate change?”.
Recent devastating US wildfires3 and the deluge of rainfall in Dubai4, highlight how climate change is playing a role in exacerbating extreme weather5. The physical impacts of these events can ultimately hit your investment returns.
Here, this article breaks down why these risks matter from a financial perspective and provides actionable insights to help your portfolio positioning.
Understanding physical climate risks
Investors should consider physical climate risks, encompassing both acute events and chronic changes, as part of their investment process6. These risks could threaten infrastructure, supply chains and operations, leading to disruptions and financial losses for companies and investors alike.
Acute events, like hurricanes, wildfires and floods, can quickly disrupt businesses, supply chains and infrastructure, leading to financial losses and lower portfolio returns.
Chronic changes, such as rising sea levels and temperature shifts, pose long-term challenges to industries like agriculture, real estate and energy, affecting the viability and value of specific assets in regions over the long term.
In combination, chronic and acute episodes can be particularly devastating – for example, coastal communities experiencing higher sea levels might then be hit by a hurricane and storm surge. When listed, the range of weather events sounds apocalyptic. However, the reality is such events are happening already, and with increasing financial impact (see chart).
Global economic losses by peril (2023 $ billion)
Losses in 2023 were higher than the average and median amounts of any year this century
Source: Aon Catastrophe Insight, Barclays Private Bank, May 2024
How physical risk affects industries
The impact of physical climate risks on business is diverse and widespread7. For example, companies could have increased operating costs. Revenues may slip from weaker demand or production capacity. Capital expenditures might increase, as asset value or useful-life decreases.
Impacts will also vary by industry. For example, in agricultural, extreme weather can cause crops to fail, reduce yields and raise production costs. The challenges faced by farmers range from disrupted planting and harvesting schedules to crop damage from floods or droughts, resulting in financial losses and food supply-chain disruptions.
Similarly, the real estate industry is vulnerable to physical climate risks, particularly in coastal areas susceptible to sea-level rises and storm surges. Properties face increased exposure to flooding and erosion, leading to dearer insurance premiums, more property damage and decreased market value. Investors holding real estate assets might want to consider the long-term implications of climate change on property values and rental income.
The table below summarises some of the physical climate impacts on specific industries and their effects on a company’s value chain8.
| Industry | Illustrative climate effects (short and long-term) | Potential impact on value chain |
| Agriculture, Food & Beverage | - Increasing average temperatures and heatwaves can lead to decreased crop yields and potential crop failures. - Floods and landslides resulting from changing rainfall patterns can cause loss of productive land and decreased soil quality. - Water scarcity and drought can increase irrigation demand and costs, altering growing conditions and seasons. |
- Decreased crop yields and potential failures can lead to revenue losses and increased production costs. - Loss of productive land and decreased soil quality might disrupt farming production and associated supply chains. - Changes in growing conditions and seasons could trigger more price volatility and distribution network disruptions. |
| Apparel | - Rising average temperatures and more frequent extreme weather events could add to the fluctuations seen in availability, quality and cost of raw materials. - Changing rainfall patterns and increased rainfall intensity can disrupt manufacturing operations and supply chains. - Shifts in pest and disease distribution and prevalence would probably impact production and product quality. |
- Fluctuating availability, quality, and cost of raw materials can disrupt manufacturing operations and supply chains. - Disruptions in supply chain and distribution network, including transport, warehouses and stores, can affect product availability and sales. - Shifting consumer preferences due to unreliable seasonal cycles and temperatures would impact demand and profitability. |
| Tourism | - Increased weather extremes and variability, such as heatwaves, droughts and wildfires, can damage infrastructure and facilities. - Rising sea levels and coastal erosion can decrease the attractiveness of tourism destinations and disrupt transportation. - Changing weather patterns and exposure to climate-related diseases can affect tourism safety and travel patterns. |
- Damage to infrastructure and facilities could hit tourist traffic and revenue loss. - Less attractive tourist destinations might cut bookings and occupancy rates. - Disruptions in transportation, including flights and cruises, can hinder tourists' ability to reach destinations, with consequences for tourism revenues. |
| Insurance | - Virtually all physical effects, including hurricanes, storms, wildfires, floods and droughts, can lead to increased claims, losses and liabilities. - Difficulty in pricing physical perils due to climate change might reduce the availability and affordability of insurance products. - Lower portfolio valuations due to climate-related financial losses and increased exposure to physical risks. |
- Increased claims, losses and liabilities can strain insurance company finances and lead to higher policy premiums. - Reduced availability and affordability of insurance products can leave assets in high-risk locations uninsured or underinsured. - Weaker investment portfolio valuations can drag down insurance company solvency levels and financial stability. |
| Electric power | - Increased intensity and duration of extreme weather events, such as heatwaves, storms and floods, can disrupt power generation and transmission infrastructure. - Rising sea levels and higher storm surges can damage coastal power plants and distribution networks. - Water scarcity might reduce output and increase operating costs for hydroelectric and fossil fuel power plants. |
- Disruptions in power generation and transmission infrastructure may cut electricity output and increase operational costs. - Damage to infrastructure and facilities can result in higher maintenance and repair expenses. - Changing seasonal power demand and increased peak demand can strain power grid reliability and increase electricity losses. |
| Oil & Gas and Mining | - Increased intensity and duration of extreme weather events, rising sea levels and coastal erosion can damage infrastructure and facilities. - Melting land and sea ice and thawing permafrost can disrupt exploration, production and transportation of resources. - Increased heat intensity and changes in pest and disease distribution and prevalence can impact employee health and safety. |
- Damage to infrastructure and facilities can lead to decreased resource production and increased operational costs. - Disruptions in exploration, production, and transportation can constrain access to and availability of resources. - Decreased workforce productivity and availability can affect asset productivity. - Rising risks to employee health and safety can result in higher insurance premiums and liability expenses. |
| Real estate | - Rising sea levels and increased storm surges can lead to coastal flooding and erosion, damaging properties and infrastructure. - Extreme weather events, such as hurricanes and wildfires, can cause property damage and disruption to real estate markets. - Heatwaves and urban heat island effects can impact building resilience and affect property values in urban areas. |
- Property damage and decreased market value can lead to financial losses for real estate developers, investors, and homeowners. - Increased insurance premiums and deductibles can raise costs for property owners and tenants. - Disruptions in construction schedules and supply chains can delay development projects and increase construction costs. |
Source: Barclays Private Bank, May 2024
Approaches to assess physical risks in portfolios
To understand and manage physical climate risks in investment portfolios, investors can adopt several practical strategies:
1. Conduct comprehensive risk assessments: Evaluate the exposure of investments to physical climate risks across different sectors, regions and asset classes. Consider factors such as geographical location, infrastructure resilience and historical climate data to identify vulnerable assets.
2. Utilise climate scenario analysis: Model potential climate scenarios and assess their impact on investment performance under different climate change scenarios. Consider factors such as changes in extreme weather patterns, sea-level rise projections, and temperature increases to gauge portfolio resilience and identify mitigation strategies.
3. Assess corporate plans and reporting: Review corporate disclosures on their exposure to physical climate risks, as well as their strategies for adaptation and resilience-building. Review reporting to understand their risk management practices and assess the effectiveness of their response strategies.
4. Integrate climate risk metrics: Incorporate climate risk metrics, such as physical risk scores and climate stress tests, into investment decision-making processes. Use quantitative tools and models to evaluate the financial implications of physical climate risks on portfolio performance and adjust asset allocations accordingly.
By assessing physical climate risks, investors can improve the resilience and sustainability of their investment portfolios, minimise potential losses, and capitalise on opportunities arising from the transition to a low-carbon economy.
Thereafter, investors can take various portfolio action. They could avoid the risks by not selecting the asset, or exiting an existing position. Alternatively, they can reprice the risks, or expected returns, as many insurance companies have begun to do. And overall, they can look to adapt their portfolio to manage within a certain risk parameters, or with expectations around various scenarios.
Prepare your portfolio today for tomorrow
Climate change isn't just a distant threat anymore; it's a present reality with potential tangible impacts on investment portfolios. Among the various potential impacts of climate change, physical risks stand out for their direct effects on industries and asset classes.
By actively analysing and addressing physical risks, you can fortify your portfolio against the threat of climate uncertainties and try to make portfolios more resilient. Don't underestimate the power of preparing today to look after your portfolios for tomorrow.
Disclaimer
This communication is general in nature and provided for information/educational purposes only. It does not take into account any specific investment objectives, the financial situation or particular needs of any particular person. It not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful for them to access.
This communication has been prepared by Barclays Private Bank (Barclays) and references to Barclays includes any entity within the Barclays group of companies.
This communication:
(i) is not research nor a product of the Barclays Research department. Any views expressed in these materials may differ from those of the Barclays Research department. All opinions and estimates are given as of the date of the materials and are subject to change. Barclays is not obliged to inform recipients of these materials of any change to such opinions or estimates;
(ii) is not an offer, an invitation or a recommendation to enter into any product or service and does not constitute a solicitation to buy or sell securities, investment advice or a personal recommendation;
(iii) is confidential and no part may be reproduced, distributed or transmitted without the prior written permission of Barclays; and
(iv) has not been reviewed or approved by any regulatory authority.
Any past or simulated past performance including back-testing, modelling or scenario analysis, or future projections contained in this communication is no indication as to future performance. No representation is made as to the accuracy of the assumptions made in this communication, or completeness of, any modelling, scenario analysis or back-testing. The value of any investment may also fluctuate as a result of market changes.
Where information in this communication has been obtained from third party sources, we believe those sources to be reliable but we do not guarantee the information’s accuracy and you should note that it may be incomplete or condensed.
Neither Barclays nor any of its directors, officers, employees, representatives or agents, accepts any liability whatsoever for any direct, indirect or consequential losses (in contract, tort or otherwise) arising from the use of this communication or its contents or reliance on the information contained herein, except to the extent this would be prohibited by law or regulation.