Weathering Climate Change: Opportunities and Risks in an Altered Investment Landscape

Abstract

After 100 centuries of relative stability, our planet’s climate is transforming. This climatic change is not a distant forecast of the future – it is verifiably happening now. Indeed, despite the significant uncertainty over the longer horizon, our climate destiny is largely predetermined over the next decade – the typical time frame of most long-term investors. Ironically, a highly certain climate destiny translates into massive uncertainty for long-term investors looking to navigate the opportunities and challenges unleashed by climate change. This is for a variety of reasons. First, the most definitive forecast of climate change is for more extreme and greater variability in weather outcomes, the precise timing and severity of which are unclear. Second, it is hard to predict when the externalities, tail risks and nonlinear vulnerabilities from climate change will be fully reflected in market prices. Third, the regulatory, governmental and societal response to climate change remains unclear, especially given the polarized political landscape in which climate change discussions are currently being conducted. Despite these uncertainties, we believe that climate change is one of the most important structural changes for long-term investors. The implications for investors lie as much around innovative and transformative technologies to further the transition to a lower-carbon world as they do around identifying and mitigating hidden vulnerabilities across their portfolio. To build an actionable climate change investment agenda, we have drawn on the insights of over 45 investment professionals across PGIM’s fixed income, equity, real estate, and private debt and alternatives managers; interviewed over 30 leading academics, economists, policymakers, scientists and climate change investors; and conducted a new proprietary survey of 100 global institutional investors to better understand their current investment actions and future aspirations around climate change. The humanitarian and economic catastrophe unleashed by COVID-19 in 2020 revealed investors’ vulnerability to nonlinear risks with unpredictable timing that are not easily accounted for in standard risk modeling. Climate change is the next slow-burning crisis that will radically reshape investors’ risks and opportunities over the next decade. Here at PGIM, we believe investors who understand the potential for climate change to disrupt and reshape the global economy, markets and the investment landscape will be best positioned to navigate the coming decades.