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Visualized: What Are the Climate Risks in a Portfolio?

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Visualized: What Are the Climate Risks in a Portfolio?

What Are the Climate Risks in a Portfolio?

A warming planet poses clear risks to society. To that end, natural disasters, policy changes, and technological shifts all have the potential to affect an investor’s portfolio. But to what extent?

We partnered with MSCI to explore the effect of climate risk on investments, and how it can be evaluated on a regional basis.

How to Assess Climate Risks

Climate Value-at-Risk (VaR) is a measure of the potential additional costs that could arise from climate change, as a percentage of a company’s valuation, so investors can be better prepared to weather the storm. It assesses two dimensions of climate risk:

1. Transition Climate VaR

This measures potential financial losses from the transition to a low-carbon economy. It has the following categories:

  • Policy risk: arises due to potential policy and regulatory changes affecting companies, including penalties, reputational damage, or loss of investor confidence.
  • Technological opportunities: arise due to shifts to new and better environmentally-friendly technologies, such as solar energy, electric vehicles, and smart grids.

2. Physical Climate VaR

This measures potential financial losses due to the physical impacts of climate change, such as heat waves, tsunamis, and crop failures.

For instance, the Pacific region, including Australia and New Zealand, is highly vulnerable to climate change given that it’s home to a number of low-lying islands.

Climate Risk, by Region

Climate risks can vary by region due to a range of factors, from climate policy to climate conditions, including increased likelihood of wildfires or flooding.

Below, we show a regional breakdown of Climate VaR. These represent the weighted average of constituents in the following MSCI indexes as of September 30, 2022. The greater the negative VaR, the greater the potential downside risk.

RegionTransition Climate VaRPhysical Climate VaR
Europe & Middle East (DM)*-2.3%-8.7%
EM** Asia-2.7%-16.9%
EM EMEA***-4.9%-11.0%
EM Latin America-5.8%-13.0%
North America-1.1%-3.8%
Pacific+0.0%-13.7%

*Developed markets. **Emerging markets. ***Europe, Middle East, and Africa. Pacific region countries include Australia, Hong Kong, Japan, New Zealand and Singapore.

Given how climate risks have the potential to affect a portfolio’s value, it pays to be proactive. The MSCI Climate VaR assesses how a company’s valuation could be impacted by climate policy and physical climate risks, as well as how it could benefit from a low-carbon technology transition.

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Explore MSCI’s paper on Understanding Climate Metrics.

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