Recent headlines have focused on carbon output and its effect on the environment right now (and into the future). According to a study from the University of Waterloo, companies that fail to curb their carbon output may face consequences of asset devaluation and stock price depreciation – and this failure to take carbon reduction action could start to negatively impact the general stock market in as little as ten years’ time.
Mingyu Fang, a Ph.D. Candidate in Waterloo’s Department of Statistics and Actuarial Science believes that “companies [that don’t curb their carbon output] are going to find that large portions of the reserves are at risk of being unexploitable for potential economic gains.”
Climate change impacts investment portfolios through two channels. Directly it elevates weather‐related physical risk to real properties and infrastructure assets, which extends to increased market risk in equity holdings with material business exposures in climate‐sensitive regions.
Indirectly, it triggers stricter environmental regulations and higher emission cost in a global effort in emission control, which shall induce downturns in carbon‐intensive industries in which a portfolio may have material positions. The indirect impact of climate change on investments will effectively be transformed into a political risk affecting particular asset classes, often referred to as the investment carbon risk.
As part of the study, which grew out of Fang’s Ph.D. thesis, as well as a funded research project by the Society of Actuaries under the theme of ‘Managing Climate and Carbon Risk in Investment Portfolios’, the researchers undertook an inter‐temporal analysis of stock returns. They examined 36 publicly traded large emitters and related sector indices from Europe and North America around the ratification of major climate protocols. Only nine of the 36 samples were found to display recognizable carbon pricing. The historical performance of the emission‐heavy sectors, such as energy, utilities, and the material was also compared against those of the other industries. The carbon-intensive sectors consistently ranked at the bottom of the list across the metrics used and underperformed the market indices for both Europe and North America.
Tony Wirjantoit, a professor jointly appointed in Waterloo’s School of Accounting & Finance and Department of Statistics & Actuarial Science, and Fang’s Ph.D. thesis supervisor explained that it is in the best interest of companies in the financial, insurance, and pension industries to price this carbon risk properly. It is necessary for companies to take climate change into consideration now in order to build an optimal and sustainable portfolio.
The study, “Sustainable portfolio management under climate change” by Fang, Wirjanto and Ken Seng Tan, another of Fang’s PhD thesis supervisors, was published in the Journal of Sustainable Finance & Investment.