Tackling the increasingly urgent issue of climate change will require enormous amounts of capital—invested smartly. In that effort, climate scientists and investors can learn a lot from each other, an idea behind the collaboration among Columbia University climate experts and AB investment professionals.
The growing threat of climate change has highlighted the challenge of quickly moving climate-science knowledge from the academic world into the hands of practitioners. These practitioners include investment managers who analyze the impact on issuers—and issuers’ impact on climate change. Both climate scientists and investors are dedicated to asking the right questions and uncovering evidence to understand issues, make rational decisions and identify solutions for the planet and the investment landscape.
Rational decision making includes working with “known knowns” and predicting outcomes based on observed trends, valid models and other data. It also deals with “known unknowns,” which force us to face uncertainty. These factors are critical in addressing the climate imperative: societies and economies must respond to the short-term and long-term impacts of humanity on Earth’s climate and environment.
Bringing More Climate Expertise into Investing
The desire to make advances drove a collaboration between Columbia University’s Earth Institute and AB—an exchange between thought leaders to bring climate knowledge into the investing profession. Columbia climate scientists, environmental law, policy and engineering experts, technology developers and researchers will partner with AB portfolio managers and analysts to take a deeper dive into how climate science can inform investing decisions.
Among the questions: How do investors proactively identify, respond to and potentially even solve for climate risks and opportunities? How do we convert joint knowledge bases into actionable opportunities? In working toward answers, we hope to learn from each other and ultimately build a broader knowledge base than we could have assembled individually.
The initial thinking was that Columbia could simply download its climate knowledge to AB through lectures and panel discussions, as in a graduate seminar. But investors’ methods of managing portfolios and advising clients are a poor match for the academic form of knowledge capital. So, we’ve done several iterations on the substance, style and delivery of climate content to create full-day workshops on climate and finance.
Columbia faculty work closely with AB’s in-house learning and development experts to create workshops that are interactive and engaging, providing the opportunity for questions and open debate that enable investors to internalize the substance of the content in their day-to-day tasks.
An Evolving Curriculum for a Dynamic Arena
The content of workshops continues to develop, with a view towards customizing materials for an audience of investors working in highly dynamic markets. Detailed post-workshop surveys and analysis help AB and Columbia identify and enhance popular modules while revising and replacing others. Each workshop starts with an overview of climate science and empirical observations, providing the foundation for discussions on risk, policy, economics and solutions. The development process has revealed that both academic climate scientists and finance professionals suffer from mutual ignorance of each other’s knowledge-to-action frameworks, which we’ve only partially bridged during initial interactions. There’s more to do.
Ultimately, we’re working toward an agenda of collaborative research that couples state-of-the-art climate and asset-pricing models to produce new tools for investors. Investors’ feedback is essential for developing those tools and so is the rapid transfer of knowledge derived from climate research. At the same time, we want to reduce the universe of “unknown unknowns” that impede work on both sides of the collaboration.
The Past: A Long Equilibrium Period between Society and Earth
Let’s start with what we do know about our planet’s climate. It has changed throughout Earth’s multibillion-year history, influenced by the interplay among geological forces, the evolution of life and the tug of the other planets on Earth’s orbit around the sun. These factors have combined over time to change the atmospheric concentrations of greenhouse gases (GHG), such as carbon dioxide.
In the more recent geologic past—leading up to the present—Earth has fallen in and out of ice ages as GHG levels and temperature have increased and decreased in cyclical lockstep. Since the end of the last ice age more than 10,000 years ago, civilization as we now know it has developed with the benefit of a nurturing environment that has enabled the advent of agriculture and the inception of an industrial economy. We’ve been living in this more or less environmentally symbiotic equilibrium until recently.
Growing Acceptance of a Changing Climate Trajectory
Since the start of the industrial revolution, and especially since the end of World War II, humans have transformed the landscape rapidly, pumping GHG and pollutants into the atmosphere at a rate never before seen in geological history. The data are undeniable: the atmosphere and the oceans have warmed, the oceans are more acidic, remaining ice sheets and glaciers are melting and sea levels are rising. In other words, the planet is out of equilibrium.
Though some debate remains, there’s broad and growing acceptance of these facts, with public awareness amplified by more frequent severe weather events. Recent examples include wildfires in California and Australia, heavy precipitation and flooding in the Midwestern US, extended drought and water scarcity in the Middle East and successive hurricanes in the Caribbean and Gulf of Mexico.
Can climate change be blamed for each of these weather events? It’s an arguable scientific point, though accumulating evidence increasingly points in that direction. What really matters right now is the rising chorus from government, society and academia demanding action from each other—and from financial markets.
Developing New Insights on Climate and Investing
Columbia’s experience in the collaboration has provided faculty and students with critical insights into the potential role for investors and academia to work together in responding to this imperative:
1) Investors’ awareness of climate risks and opportunities will factor into their decisions.
2) To address investors’ needs, tools must be developed based on a quantitative understanding of the relationship between climate risks and asset pricing.
3) New performance indicators will evolve within the perspective of regulatory oversight and investor demands.
4) Climate scientists will continue improving their understanding of Earth’s climate system and refine model predictions, and new technologies will address climate change.
Let’s take a closer look at each of these insights.
1) Climate Awareness Will Influence Investors’ Decision Making
In the public’s mind, “climate change is here” in the form of extreme events attributable to longer-term trends in the climate system. This growing perception has been on display recently in discussions at Davos, youth movements and advocacy, campus demands for fossil-fuel divestment and well-publicized litigation and shareholder activism. Political responses have varied, but several US cities and states—and most countries—have set targets for emission reduction and net-zero economies.
The finance industry’s response includes developing environmental, social and governance (ESG) products and making more green venture capital available. As the age distribution of investors skews younger, the demand for appropriate investment products will increase, and fiduciary responsibilities may well realign. We suspect that both quantitative and emotional factors will affect investment decision making.
2) The Need for More—and Better—Quantitative Tools
Climate risks affect asset pricing, and technological innovation will create new investment opportunities. The well-known impacts of extreme weather are examples of physical risk on short time scales—in the course of a single extreme event, such as a hurricane or flood.
Longer-term risks are harder to quantify and therefore harder to price: the impact of rising seas on coastal communities and assets, the amplification of wildfire hazards from extended drought and declining labor productivity as workers struggle with heat and humidity. Relating asset-class time horizons with deterministic or probabilistic models of extreme weather and climate impacts is a key goal of climate-responsive investing. Pricing climate opportunities, including new technologies, new land uses, infrastructure development and municipal services, could depend a lot on the balance between climate mitigation and adaptation.
Climate mitigation’s objective is to roll back GHG emission by reducing fossil-fuel reliance, modifying agricultural practices, removing GHG from industrial outputs, or capturing and storing GHG directly from the atmosphere. Climate adaptation involves recognizing inevitable climate-change impacts and responding with measures including physical hardening of coastlines, broader flood and storm-surge control, and advances in electric grid management systems.
Transition risks, including litigation and reputational risks or risks from policy and regulatory changes, will also affect asset prices. Transition risks can also include the risks of being left behind as new modes of manufacturing, transportation or construction emerge to mitigate and adapt to climate change. Several real-world impact examples exist, including the notable case of the Pacific Gas and Electric bankruptcy stemming from California wildfires, but there’s little quantitative experience to apply to asset pricing.
The accuracy of predicting extreme weather events over short time periods and climate-change trajectory over longer time scales varies. In many cases, sources of uncertainty are known and quantifiable. Probabilistic risk assessments and scenario analysis may be the best paths forward now, but more basic research will improve them. We’re starting to see progress in the development of tools and platforms linking climate risks to asset-pricing models, but more is needed. And ultimately, these tools must become investor resources.
3) Development of New Performance Indicators
Trends in litigation and policy discussions indicate growing need for comprehensive performance indicators related to climate. European regulators are arguably at the front line of this development, with the European Commission working to establish the European Union taxonomy classification system. It facilitates investing in economic activities that contribute to climate change mitigation and adaptation.
Within the business and finance spheres, an entire industry has developed around the production of ESG indicators, some proprietary and some open. All of them lack commonly understood methodology. Columbia is looking at broad measures of sustainability and their underlying data, and AB has begun thinking about how climate performance might be measured for different asset classes.
4) Advances in Climate Science and New Technologies
Nothing is static in the realm of climate science: the entire ecosystem of evidence-based, investment decisions that account for climate risks and opportunities will always be dynamic. Climate-systems research will continue to progress, and, as we learn more about climate, more questions will come to light.
Columbia continues to examine the causal links between climate change and impacts across a variety of sectors, while AB is tracking social, economic and cultural responses to the growing awareness of climate change. The challenge will be to work together and quickly convert this growing knowledge capital into investment practice.
The Private Sector Must Be Part of the Solution
There’s another goal to the collaboration between climate experts and investment experts. In order to contain the climate crisis in all its geographic scope and time dimensions, enormous capital resources must be brought to bear to develop solutions.
Governments can project policies, regulations and incentives, but the public sector alone doesn’t have enough capital to achieve transformation. The public sector also doesn’t have a lock on the intellectual and knowledge capital underlying practical, scalable and marketable solutions. The resources and domain expertise of the private sector must be part of the answer. A deeper partnership between climate scientists and financial professionals is the first step.
The stakes—in terms of damage from failing to adapt—are high. That means waiting for complete certainty from all scientific quarters on all facets of change isn’t an option. The rest of the world isn’t waiting, so we must understand the implications sooner rather than later. The focus of AB’s role in the collaboration needs to be squarely on how investors respond to expected major physical and social changes. That focus must come with the knowledge that we can’t understand the future with any certainty—but that we can’t use uncertainty as an excuse for failure to act.
Adding Climate to the Equation
The debate about human contributions to climate change is effectively over—settled to a degree that’s increasingly acknowledged by society. Instead, we should focus on including climate change in the spectrum of risks that inform investment decisions. The scope of the climate crisis requires it.
Developing solutions that can mitigate or adapt to climate change will create investment risks and opportunities in almost every sector and must be an important component of the conversation between investment managers and their clients. Professional investors can better arm themselves by sharpening their ability to integrate climate science into the equation.
Sara Rosner is Director of Environmental Research & Engagement—Responsible Investment at AllianceBernstein (AB). Arthur Lerner-Lam, PhD, is Deputy Director of the Lamont-Doherty Earth Observatory of Columbia University.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to change over time.