By Alan Hsu, Global Industry Analyst at Wellington Management and Dr. Philip Duffy, Ph.D, Former President and Executive Director at Woodwell Climate Research Center

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Q. How severe is the risk of climate and what value can collaboration bring?

Alan Hsu: Climate change is a mispriced risk. It has taken the investment community a very long time to recognize it as a systematic risk that impacts companies and sectors across asset classes.

Our collaboration with Woodwell Climate Research Center began in 2018, with the purpose of better understanding how climate change impacts capital markets and, ultimately, investment returns.

Dr. Philip Duffy: Human well-being depends on the natural world. A rapidly changing climate affects different societal sectors that are very finely adapted to a certain climate type. If this changes, we will have to rethink all kinds of fundamental things like the way we construct buildings, how we grow food, and how we manage water resources.

When we first started talking to Wellington Management three years ago, there was a big disconnect between the climate world and the investment world. The investment community is rapidly realizing that these physical risks are a “now” problem, and that the investment risks of climate change need to be properly evaluated in prices at some fundamental level.

Q. What are the consequences of the disconnect between climate change and investment decisions?

Phil: Wildfires, extreme heat, and floods will become more frequent with climate change. There is no question that climate change is tilting the odds for these kinds of events. Some of the recent events that we’ve experienced have been not just record-breaking, but record-breaking by enormous margins. These events suggest that there may be something fundamental going on that even the scientists don’t understand. It’s likely that these sorts of extreme events will unfold more rapidly than anticipated.

Alan: When you think about the problems associated with climate change, there is no real price signal from markets that can even remotely quantify the magnitude of the problem. Think about the lack of a price on carbon. Think about the lack of a price on water. Prices are useful because they mobilize capital to address inefficiencies, solve problems, and alleviate supply-demand mismatches. In the absence of these signals, you get sustained abuse of the natural environment and the resources that go along with it.

Q. How do we bridge the current divide between climate research and investing?

Alan: We’ve found significant value in identifying climate-driven pressures that require some form of remediation. For example, with snowpack levels falling to zero in California, hydroelectricity output statewide is about 70% less than usual — and people are using their air conditioning more because it’s become hotter. These types of interconnected climate-related pressures could lead to investment opportunities in backup power-generation assets or alternative forms of power. We might also identify solutions for making the natural environment more resilient, for example, with forestry development and more effective wildlife management.

Phil: It takes a sustained engagement between the scientific community, research community, and the investment decision makers. Each party has to understand enough about what the other party does and how they do it, so that they can communicate effectively. With some minimal understanding of the decisions that need to be made, we scientists can go back and produce information that is properly tailored to help make those decisions.

Q. Where do you see investment opportunities today, and how might these change over time?

Alan: We think about investment opportunities in two ways: climate mitigation and climate adaptation. The first attempts to solve a longer-term problem around decarbonization, while the second is recognition that no matter how much we spend on climate mitigation, we may not be able to reverse the crisis sufficiently over time, and therefore we need to develop resilience.

The kinds of investments that we should see more of in the future are those designed to adapt and help the global economy navigate through long-term physical risks. The magnitude of the need for climate resilience and managing climate risk means that we need to be developing strategic, longer-term adaptation solutions, rather than creating ones that are more tactical in nature.

Phil: It’s uncomfortable to contemplate what’s happening. However, despite having no warnings, it’s true that in many cases, well-designed, adaptation spending upfront is very cost-effective. Investing money pre-disaster can save multiples of that amount of money post such a disaster.

In terms of decarbonization, there are a lot of things we already know how to do. The electricity sector can easily decarbonize with technologies that we have today. Further investment in this area would drive the agenda forward. In addition, there are still unsolved challenges: How do we decarbonize aviation, heavy industry, or shipping, for instance? There are some interesting technological challenges where the investment industry can allocate capital to help develop viable solutions.

Q. What advice would you give to others that are eager to mobilize capital to the climate crisis?

Alan: A first step is to expand research sources. Our partnership with Woodwell allowed us to gain foresight into some of the risks that we’ve since seen in the past year or so.

The second step is to begin to think about a company’s physical dependencies. I don’t think people would have understood a year ago that semiconductor companies, which are concentrated in Taiwan, need significant amounts of water. The worst drought on the island of Taiwan in 100 years exposed these companies, which are vital for the operations of many other industries, to acute climate risk. Being able to think broader, more expansively, and incorporating other viewpoints helped us get to the point where we are at today.

1.This article summarizes a recent AVPN podcast hosted by Tech for Impact founder and CEO Teymoor Nabili, Wellington Management’s Alan Hsu and Dr. Philip Duffy of Woodwell Climate Research Center


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