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Adapting to climate change: Investing in the resiliency imperative

As the risks of climate change increase, so does the need to build resiliency. Members of our Climate Research Team discuss why they believe demand for climate adaptation solutions could grow exponentially, and how they think about investing in solutions for a range of climate variables, including heat, flooding, wildfires, and water scarcity.

The views expressed are those of the authors at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.

KEY POINTS

  • Climate change is accelerating, and society is underprepared for the rising human, environmental, and economic toll.
  • We believe demand for climate adaptation solutions will increase significantly.
  • By investing in climate adaptation, investors can help address the climate challenge, gain exposure to a growing and inefficient market segment, and hedge portfolio exposure to climate risk.

Combating climate change is fast becoming an economic necessity. Swiss Re estimates global GDP could shrink 18% by 2050 if global temperatures are allowed to rise by 3°C.1 To date, most efforts have focused on mitigating climate change through regulation or carbon pricing, while spending on innovations to help society adapt to physical climate threats has lagged. Our work with Woodwell Climate Research Center gives us conviction that physical climate risks will rise significantly over the next 10 to 30 years, driving demand and expanding markets for adaptation solutions. This thesis is corroborated by the United Nations Intergovernmental Panel on Climate Change’s (UN IPCC’s) recent report, which calls for an increase in adaptation investment across public and private sectors to build resilience to climate extremes and climate variability.2

In this paper, we share why we believe market growth for climate adaptation has been slow and how a growing need for climate resiliency will accelerate investment. We also share how we translate insights we have gained from Woodwell’s climate research into our investment process. Finally, we discuss why we believe investors need to think differently about climate adaptation, adopting longer time horizons and accepting uneven growth in a segment we believe can outpace broader markets over time.

Society is unprepared for climate-related costs

Climate change is inevitable. Most greenhouse gases (GHGs) remain in the earth’s atmosphere long after they are released. Because their warming effects linger for decades or centuries, future warming of 1.5°C is already “baked in” and unlikely to reverse, regardless of mitigation pathways taken.3 Woodwell projects increasing frequency and intensity in heat waves, droughts, wildfires, flooding, and hurricanes. At the same time, water shortages and rising sea levels threaten livability in many regions.

Overall, society remains underprepared for the potentially devastating human, environmental, and financial toll of climate change. In just the past few years, the numbers have been staggering:

  • In 2020, global losses from natural disasters totaled US$210 billion; the cost of climate-related disasters across Asia reached US$67 billion.4 The US suffered 22 separate billion-dollar weather disasters in 2020.5
  • 2020 was the most active hurricane season in 170 years, when reliable record keeping began. The cost of 2020 Atlantic storms was nearly US$47 billion.6
  • 2020 was also the second-warmest year on record; global land and ocean surface temperatures departed from averages by +0.98°C (+1.76°F), the largest margin ever.7
  • During the 2019 – 2020 bushfire season, a record 18 million hectares burned across Australia. The costs to industry and tourism approach US$2.9 billion. Entire species of animals may be at risk of extinction from this one devastating period.8
  • California’s 2020 wildfires destroyed over 10,000 structures and cost over US$12 billion in damages (US$10 billion in property damage and US$2 billion in fire suppression costs).9
  • During the 2020 monsoon season, China experienced massive river overflow, with approximately 40 major waterways reaching the highest levels ever recorded. In May 2021 — prior to this year’s monsoon season — 97 rivers across China exceeded high-water warning levels.10
  • Negative trends have continued in 2021. Northwestern US and Canada have experienced record heatwaves. Wildfires have created smokey haze over cities on the US eastern seaboard, 3000 miles away. Significant floods in Europe have killed hundreds and washed away entire towns. A drought-driven water shortage in Taiwan has affected daily life and disrupted the global technology supply chain.

Why the slow uptake on climate adaptation?

Amid scientific evidence of accelerating climate change and the massive costs of climate-related damage, why has the investment community been relatively slow to focus on adaptation? We believe there are two main reasons: reliance on pattern recognition and market short-termism.

Because humans tend to rely on pattern recognition for decision making, it can be difficult to acknowledge or accept paradigms that deviate from past experience. Familiar patterns or datasets give us mental comfort on which to base decisions and take risks. Climate change does not offer such comfort. According to Woodwell, we should not rely on historical data and patterns to project climate conditions. Their projections show that the climate will be more volatile over the next three decades than the last three. Heat will threaten the health of vulnerable populations. The probability of hurricanes, floods, and wildfires is rising. Seasonal precipitation will oscillate between dearth and deluge. And water scarcity will disrupt industries from agriculture to energy to semiconductors.

Short-termism, exacerbated by a misreading of future climate risk, is likely compounding inaction on adaptation. Investors are typically evaluated (and incentivized) on one-, three- and five-year performance. Many investors assume that the consequences of climate change — and, therefore, the need to adapt — are far in the future, and hence they need not be factored into current investment decisions.

In our view, the rising frequency and cost of climate events disprove that assumption: Climate change is both a near-term and a longer-term risk. While the market impacts of climate change may not appear material in diversified portfolios today, we believe the risks are rising. A tipping point that results in rapid, widespread asset repricing could expose higher risk levels and thus a greater need for climate hedges than otherwise expected.

Rising tide of spending on climate adaptation

The growing realization that lives and assets are increasingly exposed to climate risk is beginning to shift capital flows toward adaptation. We believe this trend will…

To read more, please click the download link below.

1“World economy set to lose up to 18% GDP from climate change if no action taken, reveals Swiss Re Institute’s stress-test analysis,” SwissRe, 22 April 2021. | 2“Climate Change 2021: The Physical Science Basics,” UN IPCC, August 2021. | 3Woodwell Climate Research Center | 4“Record hurricane season and major wildfires: The natural disaster figures for 2020,” Munich RE, January 2021. | 5“Billion-Dollar Weather and Climate Disasters: Overview,” NOAA Centers for Environmental Information, 2021. | 6“2020 Atlantic hurricane season,” Center for Disaster Philanthropy, 1 December 2020. | 7US National Oceanographic and Atmospheric Administration (NOAA). | 8Center for Disaster Philanthropy. | 9“Billion-Dollar Weather and Climate Disasters: Overview,” NOAA Centers for Environmental Information, 2021. | 10“China swings into flood defenses as 97 rivers exceed warning levels,” Global Times, 27 May 2021.

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