IMPROVING RETURN TO RISK RATIOS BY REDUCING CLIMATE RISK EXPOSURES; THE RACE TO NET-ZERO URGENTLY REQUIRES THIS

By Entlligent’s Dr. Pooja Khosla and Nobel-Laureate climate scientist David Schimel

 

The urgent appeal delivered by scientists since the first Earth Summit in 1991 to reduce emissions and mitigate climate change has been heard around the world. However, this message is still ineffective, as emissions have grown year after year. Though we are seeing lots of commitments by countries and corporations, we are yet to see any real and measurable, globally applicable solutions.

 

It is also crucial to recognise that the net-zero economic transition isn’t only about divestment from traditional fuels and so called dirty economic sectors, by funding deep green activities and blacklisting black dark brown ones. Some critically important sectors and regions are severely penalized this way. We need a broader and just vision here; we need fifty shades of green to catalyze and support all companies in all sectors and regions moving towards net zero.

 

In each sector and region of our global economy, there will be leaders and laggards in reducing climate change transition risk. Leaders tend to be the companies that are reducing their energy source dependency and thus their carbon emissions profile. Institutional and wholesale portfolios must be identifying high- and low-climate-risk securities through a systematic approach. But this approach requires critical data on climate change risk to in order to price market assets adjusting for climate change risk.

To make this approach work we need to build a market solution along with policy interference. The more investors help portfolio companies and assets move towards net zero, the more they will reinforce the emerging need of metrics, targets and regulations supporting this solution. We just need the right demand from investors, and market will move towards sustainable climate solutions. With the market demanding environmental values, Adam Smith’s ‘invisible hand’ will work for achieving climate equilibrium as well.

Such a discussion and solution are presented in Entelligent’s (in partnership with Societe Generale) new report – Smart ClimateR – A Market Approach to Transition Risk. The report highlights how three Rs: References, Reporting and Returns can be integrated to create both financial and environmental values.

 

The first R, ‘References’, implies climate scenarios and targets that we need to achieve a sustainable future. The report scientifically elaborates on plausible climate futures and related outcomes.

 

The second R, ‘Reporting’ implies efforts of bodies such as the Sustainability Accounting Standards Board (SASB) and the Task Force on Climate-Related Financial Disclosures (TCFD) in developing standards and recommendations for improving transparency and understanding of the level of climate change risk within organisations. This also includes the role of policymakers and regulators to integrate a forward-looking big data approach with their existing themes. This integration helps mobilize capital towards companies that are accelerating towards a net zero economy.

 

The third R: Returns, here implies by applying the right approach that includes extensive breadth of climate science data available, ClimateTech can be integrated into the financial markets to create environmental values by accelerating net zero pathways and Paris Agreement alignments as well as attractive financial returns.

 

This report demonstrates how Entelligent rule-based stock screening and portfolio construction using climate risk data can improve financial and environmental performance relative to standard benchmarks. This finding is consistent across multiple benchmarks (S&P 500, Russel 1000 and MSCI ACWI), multiple time periods (3, 5 and 10-year back tests) and multiple portfolio strategies (US large cap growth, US mid to large cap diversification, and global-economywide exposure). In conclusion the report makes a bold point that there is a way where value (environmental) will add value (financial).

 

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