Originally published on Morgan Stanley Insights

By Lily Trager
Wealth Management, Head of Investing with Impact

As 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 eight to nine inches since 1880;¹ a process that is rapidly accelerating,² and threatening major global cities like Jakarta, Lagos, and Miami.³ In 2021, according to the National Oceanic and Atmospheric Administration (NOAA), the United States experienced “20 weather/climate disaster events with losses exceeding $1 billion each…These events included 1 drought event, 2 flooding events, 11 severe storm events, 4 tropical cyclone events, 1 wildfire event, and 1 winter storm event.” Separate analysis showed that over the last five years, the United States has experienced $750 billion in total damages from extreme weather events. Attribution science makes clear that global temperature rise leads to an increase in the frequency and intensity of extreme weather.

But it’s not necessarily all doom and gloom. As someone who creates investment portfolios that aim to have positive social and environmental impact, I’ve seen that investors can play a role in bringing about change, and that can include managing for factors related to transitioning to a low carbon economy to mitigate and adapt to the worst effects of climate change.

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

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.

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 heavy carbon emitting industries.

We launched the award-winning⁴ and patented⁵Morgan Stanley Impact Quotient^® application to help investors align their investments with unique environmental and social goals, and avoid objectionable sectors or geographies. Investors can evaluate their portfolio across 100+ environmental and social issues such as Energy Efficiency, Renewable & Cleaner Energy, and Environmental Leaders in Traditional Energy, as well as those with sustainable corporate practices such as Carbon Emissions Reporting.

As economies around the world transition to lower carbon economies, investors could benefit from reducing their exposure to traditional energy sectors, investing in funds and companies that are positioning themselves for this transition, or focusing on specific themes such as renewable energy, biofuels, and green hydrogen, or innovative technologies such as electric vehicles and carbon capture and storage.

Consider these facts: Renewable energy sources are now cost competitive in many markets. The cost of utility-scale solar energy decreased 85% from 2010 to 2020⁶ and renewables are set to account for almost 95% of the increase in global power capacity through 2026.⁷

Reputational Risk

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

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

One approach is to consider investing across various sectors of the economy, for example traditional energy, but only in companies that have industry leading environmental, social and governance (ESG) practices. That might mean investing in companies with sound corporate climate policies in place or those that disclose their carbon footprints as well as disclose 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 companies from a best-in-class environmental, social and governance perspective, investors may be able to eliminate the worst offenders and position their portfolio in companies with high standards of sustainable corporate practices across various 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 sustainable and resilient agriculture, water infrastructure or carefully evaluate companies with operations tied to parts of the world where food or water could be scarce and avoid if the risks are too great.

In the U.S., heat waves and drought greatly affect agricultural production, including corn, wheat, soy and cotton. Without adaptation, estimates show that agricultural profits for common crops could fall 30% by 2070, thanks to climate change.⁸

Seizing these Opportunities

A Morgan Stanley Financial Advisor can help identify opportunities for climate solutions investments, such as companies that are developing new and innovative technologies for renewable and alternative energy sources. Examples include:

• Leveraging existing portfolio solutions that:
  • address multiple environmental themes focused on climate change mitigation and adaptation as well as
  • seek to advance key environmental United Nations Sustainable Development Goals, such as Affordable and Clean Energy, Industry Innovation and Infrastructure, and Climate Action, or
• Creating a custom solution that tailors to specific financial and impact goals

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”, whose proceeds have a stated purpose that will seek to promote climate mitigation activities or other environmental sustainability projects. The opportunity in green bonds is vast, with issuance exceeding $550 billion in 2021 alone.⁹ 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 receive a similar return to a traditional bond.

Finally, qualified investors can generate additional positive environmental impact by accessing opportunities in the private markets (private equity, real estate and hedge funds), which could include projects such as developing sustainable agriculture solutions or financing green energy projects.

As someone who spends time understanding the influence of climate change on investors’ portfolios, as well as the emerging opportunities to help create a lower carbon economy, I believe that the most important thing is to take action. 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.

_{¹https://www.climate.gov/news-features/understanding-climate/climate-change-global-sea level#:~:text=Global%20mean%20sea%20level%20has,of%20seawater%20as%20it%20warms.}

_{²https://oceanservice.noaa.gov/facts/sealevel.html /}

_{³ https://www.newsweek.com/these-five-cities-are-vulnerable-rising-seas-including-miami-new-york-1486575}

_{⁴ Morgan Stanley Impact Quotient was the 2019 winner of the Money Management Institute & Barron's Sustainable Investing Award}

_{⁵ U.S. Pat. No. 11,188,983}

⁶ https://www.irena.org/publications/2021/Jun/Renewable-Power-Costs-in-2020

_{⁷ https://www.iea.org/news/renewable-electricity-growth-is-accelerating-faster-than-ever-worldwide-supporting-the-emergence-of-the-new-global-energy-economy}

_{⁸ https://www.nature.com/articles/s41467-020-18725-w}

_{⁹ https://mssbcie.ms.com/ri/#/reportDetail?page=reportdetails&lookup=db0f53a6-51ea-11ec-8f40-b2fe5d9c6937&previousPage=Search%20Results&previousUrl=%2Fsearch;lookup%3Dgreen%2520bond~sort%3Drelevance~pageIndex%3D1}

_{Risk Considerations}

_{Investing in the market entails the risk of market volatility. The value of all types of investments may increase or decrease over varying time periods.}

_{The returns on a portfolio consisting primarily of Environmental, Social and Governance (“ESG”) aware investments may be lower or higher than a portfolio that is more diversified or where decisions are based solely on investment considerations. Because ESG criteria exclude some investments, investors may not be able to take advantage of the same opportunities or market trends as investors that do not use such criteria.}

_{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.}

_{Please note that there is currently no standard definition of green bond. Without limiting any of the statements contained herein, Morgan Stanley makes no representation or warranty as to whether this bond constitutes a green bond or conforms to investor expectations or objectives for investing in green bonds. For information on characteristics of the bond, use of proceeds, a description of applicable project(s), and/or any other relevant information about the bond, please reference the offering documents for the bond.}

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_{Investing in Sector Investments Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies.}

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

_{Investing in emerging markets involves certain consideration not usually associated with investing in developed countries, including political and economic situations and instability, adverse diplomatic developments, price volatility, lack of liquidity and fluctuations in the currency exchange.}

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

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