Satyajit Bose: No asset manager worth her salt ever complains about the uncertainty of long-term earnings forecasts and the wide range of potential future valuation multiples. It’s part of the daily practice of an active asset manager to embrace uncertainty and look for mispricing before initiating a position, and also to monitor the evolution of uncertainty and the dispersion of information in the marketplace to anticipate paradigm shifts in pricing. Climate data from companies is just one source of information—necessary, but not sufficient—similar to earnings forecasts. The best way for analysts and portfolio managers to integrate climate risks and opportunities is to strive continuously to understand the science of the physical processes of climate change, to use their understanding of political risk and social systems to anticipate policy responses, to ask how underlying cash flows will be affected, how the natural and human capital which forms the foundation of those cash flows will be affected, and how the market’s perception of value will change.
Michelle Dunstan: While the range of climate change outcomes is wide, it is not infinite. Research is based on both modern science (e.g., how much water is contained in the Greenland and Antarctic ice sheets and how would a two-degree temperature rise impact sea levels) and analyzing historical periods—paleoclimatology (e.g., where was the sea level the last time the Earth’s temperature was two degrees warmer). These scenarios and boundaries help us analyze a company’s resilience to a range of impacts. For instance, if a company’s cash flows were basically unaffected by a severe climate change scenario, our analysts can have a high degree of confidence in that investment under any potential climate change outcome. However, if a company suffers severe cash flow degradation in all but the most minimal of climate change impact scenarios, we’d be very cautious about adding that stock to a portfolio. This can allow a portfolio manager to diversify climate change benefits and risks across a portfolio, just as they would for any other factor with an uncertain outcome.
Shawn Keegan: Even as companies provide more climate-related data out to investors, there are still many challenges to using this data within an investment process. The depth and consistency of the data varies. Not all companies are putting out climate-specific data, so it’s often hard to draw comparisons across an industry or companies. Specific data points and formats are provided by companies without any set of standards for investors to use within their investment process.
As a result, we think investors must first have their own climate change forecasts. Then, assumptions used by companies can be assessed in the same way as typical financial data released by companies is evaluated.