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PGIM Lays Out Investment Risks and Opportunities in Climate Change with “Weather Fear Gauge Near All-time Highs”

March 10, 2021

The next 15 years of climate change ‘certainty’ are already locked in, but this translates into massive ‘uncertainty’ for long-term investors, because the most definitive forecast within this global outlook is for greater variability in weather and more extreme weather events, PGIM’s latest ‘Megatrends’ research: Weathering Climate Change, says.  If there were a VIX, (the financial markets volatility ‘fear gauge’) for weather, it would already be near all-time highs, the report said.

“Climate change is the next crisis that will radically reshape investors’ risks and opportunities. Investors that take action now can play an influential role in driving the global transition to a low-carbon economy, while optimizing their portfolios for a greener future,” Taimur Hyat, Chief Operating Officer PGIM, said. Climate risks are spurring a generational reallocation of resources and the emergence of a new set of winners and losers by country and sector. PGIM expects markets to reprice across all asset classes, which is a material consideration for all investors.

The report states it is no longer a matter of ‘if’ a repricing of climate risks will occur, but rather ‘when’ and ‘how’ and it is yet unclear whether this will be an orderly transition ushered in by government measures and gradual market adjustments or an abrupt, sharp decline in sentiment triggered by a series of local climate ‘Minsky moments,’ – a sudden major collapse in asset prices.

The report highlights that:

  • The impact on productivity and growth will be highly uneven, with significant variability between, and even within countries, especially across emerging markets. (South Africa, Brazil, Indonesia, Philippines and India are in the highest climate risk group within the MSCI Emerging Market Index. Within the JP Morgan Global Bond Index this includes: South Africa, Brazil, Turkey, Mexico and Peru).
  • There will be a ‘prolonged sunset’ for fossil fuels, with the transition to a low-carbon economy playing out over a significantly longer time horizon than many investors might be expecting.
  • The indirect knock-on effects, such as ‘climigration’, civil and political unrest, water and food scarcity and more widespread zoonotic diseases, could be as consequential as the direct effects of climate change.

PGIM highlights five catalysts that may drive a more significant repricing of climate change risk across asset classes, sectors, companies and individual securities:

  • The growing perception that climate change is reaching a tipping point
  • The availability of better disclosures and data to analyse physical and transition climate risks
  • An array of policy initiatives looking to fully price climate change externalities
  • The shifting sentiment of investors and consumers
  • The potential for greater corporate climate liability

Asset Class Implications
Investment opportunities for infrastructure, private and public equities and real estate remain substantial despite the investment risk associated with climate change according to global investment decision makers surveyed by PGIM with infrastructure seen to offer the most opportunities. PGIM suggests a number of investment themes including:

Fixed income: By adopting a framework that considers both climate vulnerability and long-term readiness, investors can capture opportunities in sovereign and US municipal debt
Public and private equities: With markets pricing “brown” industries for obsolescence, active investors can seize long-term opportunities for outperformance with the “greenest” firms within brown industries.
Real Estate: By leveraging next-generation climate analytics, real estate equity investors can capture opportunities where the broad market sees mostly risk.
Infrastructure: Ageing energy infrastructure creates new opportunities in solar and wind projects in less saturated markets, for example in South American countries such as Uruguay and Chile.

Source: PGIM 2020 Climate Change Investor SurveyNote: This survey was conducted along with Greenwich Associates and included 101 participants from across North America, EMEA and APAC. Participants were chief investment officers or senior decision makers at institutional investor organizations including pension plans, insurance companies, endowments, foundations, sovereign wealth funds and central banks.

Portfolio Implications
With more 40% of 100 Global CIOs surveyed by PGIM not yet incorporating climate change in their investment process most frequently citing a lack of reliable modelling and data as the reason, PGIM’s report highlights a range of cross-portfolio implications for CIOs to consider, including:

  • The use of alternative data sources and techniques to better understand cross-portfolio climate risk and the use of unconventional methodologies and data sources – such as updated flood maps and satellite imagery to fully assess the climate exposure in portfolios
  • Evaluating different approaches to integrating climate change into portfolio risk management, each of which offers a different degree of complexity, granularity and actionability. These range ranging from a portfolio-wide climate risk analysis to targeted climate stress tests focused on specific policy interventions to comprehensive climate scenario modelling.
  • Looking beyond obvious physical risk to identify embedded climate risks across portfolios with the potential for climate change to disrupt supply chains not commonly thought of as being highly exposed to climate risk (e.g., in the pharmaceutical and semiconductor sectors).
  • Monitoring emerging “green” asset classes for investment viability such as green bonds, solar ABS, carbon emissions allowances and resiliency bonds which are still at a nascent stage and likely not fully viable for most institutional investors.

The full report is downloadable via this link and attached.

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