Risks and Opportunities of Climate Change

Happy Earth Day.

As extreme weather events make global headlines and scientists warn about a shifting climate, more investors are thinking about environmental risks and how they might affect their portfolios. After all, global sea levels have risen nearly eight inches since 1880;[1] NASA satellite imaging indicates that this process is accelerating rapidly,[2] threatening major global cities like Shanghai, Osaka, and Miami.[3]

But it’s not necessarily all doom and gloom. As someone who creates portfolios that aim to have positive social and environmental impact, I’ve seen that investors can play a role in bringing about change and managing for factors related to climate change can lead to opportunities.

Here are four significant business risks associated with climate change and some ideas for how investors can play a role in mitigating them.

Damage to Buildings and Operations

Risk: Physical damage to buildings, supplies and equipment as a result of flooding or other extreme weather events can be costly. These events can also disrupt business by halting manufacturing or making it impossible for employees to get to work.

Opportunity: Companies around the world are preparing for climate change and as a result, they are investing in resilient buildings that can better withstand damage from storms, strong winds and flooding.

Developing countries may offer investment opportunities in new construction and infrastructure projects that are built to hold up under extreme weather events. In the U.S., investments can include companies that help refit existing buildings and reinforce energy infrastructure for more resilience.

For investors, the opportunities are twofold: energy conservation within existing infrastructure in developed economies, and integration of resource efficiency in new commercial construction in emerging markets. Furthermore, the share of companies in the “green” construction market is expected to grow to 36% from 18% in 2018. [4]

Opportunity Cost

Risk: Companies that stick with processes and products that are seen as environmentally “dirty” can miss out on new opportunities for growth.

Opportunity: Invest in companies that are on the leading edge of creating products that help the environment and also help other companies get out of “dirty” industries.

This is a fast-growing area. In 2017, Morgan Stanley launched the Climate Change Mitigation Index, which highlights the potential for innovations that mitigate climate change and provide potential market-rate returns. According to information in that report, total investments in renewable energy are estimated to reach $5.1 trillion globally by 2030.

As economies around the world transition to lower carbon economies, investors could benefit from investing in companies that are positioning themselves for this transition and mitigating the effects of climate change.  

Consider these facts: Renewable energy sources are now cost competitive in many markets. The cost of utility-scale solar energy declined nearly 30% in the first quarter of 2017 alone,[5] and by some estimates, the cost of new solar electricity could drop 66% by 2040, and the cost of offshore wind power could drop by 71% over the same period.[6]

Reputational Risk

Risk: Customers may shun a company that is involved in an environmental or public relations crisis.

Opportunity: Invest in all sectors, but choose companies with the best quantitative and qualitative disclosure and management practices.

One approach is to invest across all sectors of the economy, including traditional energy, but only in companies that have industry leading quantitative and qualitative environmental, social and governance practices. That might mean investing in companies with sound corporate climate policies in place or those that disclose their carbon and water footprints as well as reduction targets over-time.  With regard to the environment, a number of companies have made sustainability pledges, such as achieving carbon neutrality by a certain date, relying more on alternative energy or cutting usage through efficiency.

This also can include companies with better safety records and more diverse boards. By investing in best-in-class companies from an environmental, social and governance perspective, investors may be able to eliminate the worst offenders and position their portfolio in leading sustainable corporate practices across all industries.

Disruption of Food and Water Supply

Risk: A shortage of drinking water or food can affect companies in parts of the world prone to droughts, heat waves or pollution.

Opportunity: Invest in clean farming, water purification systems or evaluate carefully companies with operations tied to parts of the world where food or water could be scarce.

In the U. S., heat waves and drought greatly affect agricultural production, including corn, wheat, soy and cotton. Without adaptation, some estimates show crop yields in Midwestern and Southern counties declining more than 10% during the next 20 years.[7]

In developing nations, businesses can suffer when both employees and customers struggle with health issues or need to spend most of their income on basics, like food, rather than participating in the broader economy.

Seizing these Opportunities

A financial advisor can help identify opportunities for sustainable impact investments. Another option is an automated investment platform that includes climate solutions to account for some of these environmental risks and opportunities. It’s not just for the equity side of a portfolio either. Investors can buy bonds of companies with sound environmental policies or choose to buy corporate bonds issued as “green bonds.”  Research from Morgan Stanley & Co. finds that the opportunity in green bonds is vast: Approximately $90 trillion will be required in infrastructure investment over the next 15 years to transition to low-carbon economies. Green bonds will be a key financing instrument in achieving this.

Investors with the goal of achieving positive environmental impact can look to green bonds for an accessible way to invest in low-carbon assets that may to receive a similar return to a regular bond.

As someone who spends a good part of her days researching the influence of climate change on investors’ portfolios as well as the emerging opportunities, I believe that the most important thing is to take action, no matter how small or insignificant it may seem. Climate change poses a complex, systemic global challenge, but its risks can be mitigated and an investment portfolio, no matter the size, can play a role.

Risk Considerations

Bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally the longer a bond's maturity, the more sensitive it is to this risk. Bonds may also be subject to call risk, which is the risk that the issuer will redeem the debt at its option, fully or partially, before the scheduled maturity date. The market value of debt instruments may fluctuate, and proceeds from sales prior to maturity may be more or less than the amount originally invested or the maturity value due to changes in market conditions or changes in the credit quality of the issuer. Bonds are subject to the credit risk of the issuer. This is the risk that the issuer might be unable to make interest and/or principal payments on a timely basis. Bonds are also subject to reinvestment risk, which is the risk that principal and/or interest payments from a given investment may be reinvested at a lower interest rate.

Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.

Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.

Rebalancing does not protect against a loss in declining financial markets.  There may be a potential tax implication with a rebalancing strategy.  Investors should consult with their tax advisor before implementing such a strategy.

Investing in foreign emerging markets entails greater risks than those normally associated with domestic markets, such as political, currency, economic and market risks.

Investing in foreign markets entails greater risks than those normally associated with domestic markets, such as political, currency, economic and market risks.

Certain securities referred to in this material may not have been registered under the U.S. Securities Act of 1933, as amended, and, if not, may not be offered or sold absent an exemption therefrom.  Recipients are required to comply with any legal or contractual restrictions on their purchase, holding, and sale, exercise of rights or performance of obligations under any securities/instruments transaction.

Disclosures

Morgan Stanley Wealth Management is the trade name of Morgan Stanley Smith Barney LLC, a registered broker-dealer in the United States. This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy.  Past performance is not necessarily a guide to future performance.

The author(s) (if any authors are noted) principally responsible for the preparation of this material receive compensation based upon various factors, including quality and accuracy of their work, firm revenues (including trading and capital markets revenues), client feedback and competitive factors.  Morgan Stanley Wealth Management is involved in many businesses that may relate to companies, securities or instruments mentioned in this material.

This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security/instrument, or to participate in any trading strategy. Any such offer would be made only after a prospective investor had completed its own independent investigation of the securities, instruments or transactions, and received all information it required to make its own investment decision, including, where applicable, a review of any offering circular or memorandum describing such security or instrument.  That information would contain material information not contained herein and to which prospective participants are referred. This material is based on public information as of the specified date, and may be stale thereafter.  We have no obligation to tell you when information herein may change.  We make no representation or warranty with respect to the accuracy or completeness of this material.  Morgan Stanley Wealth Management has no obligation to provide updated information on the securities/instruments mentioned herein.

The securities/instruments discussed in this material may not be suitable for all investors.  The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives.  Morgan Stanley Wealth Management recommends that investors independently evaluate specific investments and strategies, and encourages investors to seek the advice of a financial advisor. The value of and income from investments may vary because of changes in interest rates, foreign exchange rates, default rates, prepayment rates, securities/instruments prices, market indexes, operational or financial conditions of companies and other issuers or other factors.  Estimates of future performance are based on assumptions that may not be realized.  Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates. Other events not taken into account may occur and may significantly affect the projections or estimates.  Certain assumptions may have been made for modeling purposes only to simplify the presentation and/or calculation of any projections or estimates, and Morgan Stanley Wealth Management does not represent that any such assumptions will reflect actual future events.  Accordingly, there can be no assurance that estimated returns or projections will be realized or that actual returns or performance results will not materially differ from those estimated herein. 

This material should not be viewed as advice or recommendations with respect to asset allocation or any particular investment. This information is not intended to, and should not, form a primary basis for any investment decisions that you may make. Morgan Stanley Wealth Management is not acting as a fiduciary under either the Employee Retirement Income Security Act of 1974, as amended or under section 4975 of the Internal Revenue Code of 1986 as amended in providing this material except as otherwise provided in writing by Morgan Stanley and/or as described at www.morganstanley.com/disclosures/dol.

Morgan Stanley Smith Barney LLC, its affiliates and Morgan Stanley Financial Advisors do not provide legal or tax advice.  Each client should always consult his/her personal tax and/or legal advisor for information concerning his/her individual situation and to learn about any potential tax or other implications that may result from acting on a particular recommendation.

This material is disseminated in Australia to “retail clients” within the meaning of the Australian Corporations Act by Morgan Stanley Wealth Management Australia Pty Ltd (A.B.N. 19 009 145 555, holder of Australian financial services license No. 240813).

Morgan Stanley Wealth Management is not incorporated under the People's Republic of China ("PRC") law and the material in relation to this report is conducted outside the PRC. This report will be distributed only upon request of a specific recipient. This report does not constitute an offer to sell or the solicitation of an offer to buy any securities in the PRC. PRC investors must have the relevant qualifications to invest in such securities and must be responsible for obtaining all relevant approvals, licenses, verifications and or registrations from PRC's relevant governmental authorities.

If your financial adviser is based in Australia, Switzerland or the United Kingdom, then please be aware that this report is being distributed by the Morgan Stanley entity where your financial adviser is located, as follows: Australia: Morgan Stanley Wealth Management Australia Pty Ltd (ABN 19 009 145 555, AFSL No. 240813); Switzerland: Morgan Stanley (Switzerland) AG regulated by the Swiss Financial Market Supervisory Authority; or United Kingdom: Morgan Stanley Private Wealth Management Ltd, authorized and regulated by the Financial Conduct Authority, approves for the purposes of section 21 of the Financial Services and Markets Act 2000 this material for distribution in the United Kingdom.

Morgan Stanley Wealth Management is not acting as a municipal advisor to any municipal entity or obligated person within the meaning of Section 15B of the Securities Exchange Act (the “Municipal Advisor Rule”) and the opinions or views contained herein are not intended to be, and do not constitute, advice within the meaning of the Municipal Advisor Rule.

This material is disseminated in the United States of America by Morgan Stanley Smith Barney LLC.

Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness, or timeliness of the data they provide and shall not have liability for any damages of any kind relating to such data.

This material, or any portion thereof, may not be reprinted, sold or redistributed without the written consent of Morgan Stanley Smith Barney LLC.

© 2018 Morgan Stanley Smith Barney LLC. Member SIPC.

CRC# 2096753    04/2018

Sources

[1]https://www.epa.gov/climate-indicators/climate-change-indicators-sea-level 

[2]https://www.nasa.gov/feature/goddard/warming-seas-and-melting-ice-sheets

[3]https://www.theguardian.com/cities/ng-interactive/2017/nov/03/three-degree-world-cities-drowned-global-warming

[4]Dodge Data and Analytics, “World Green Building Trends 2016: Developing Markets Accelerate Global Green Growth”, 2016. Available at: http://fidic.org/sites/default/files/World%20Green%20Building%20Trends%202016%20SmartMarket%20Report%20FINAL.pdf

[5]https://www.nrel.gov/news/press/2017/nrel-report-utility-scale-solar-pv-system-cost-fell-last-year.html

[6]"New Energy Outlook for 2017." Bloomberg new Energy Finance.

[7]Gordon, Kate. “The Economic Risks of Climate Change in the United States.” Risky Business Project.