Analysis & Opinion

Investors Should Consider Climate Change as More Than a Low Probability 'Tail Risk'

A playbook for long-term investment strategy

BOSTON, MA–(Marketwired – Dec 23, 2015) – Institutional investors may be wise to rethink their approach to climate change, amid signs that they may not be taking sufficient account of the risks to their assets.

In a report, Risks and Opportunities from the Uncertain and Changing Climate: Playbook for the Truly Long-Term Investor, Cambridge Associates, global investment adviser to more than 1,000 institutional and private clients, observes that many investors categorize climate change as a low probability “tail risk.” They give “a zero or near-zero weighting in their risk models,” effectively “discounting risks related to climate change as a non-issue for their portfolios.”

“We have not seen many investors factoring climate change into their decision making in a meaningful and holistic way,” said Liqian Ma, senior investment director at Cambridge Associates, lead author of the report, and recent speaker at the Climate & Capital conference in Paris.

According to the Cambridge report, considering climate factors is an economic risk management and opportunity capitalization issue core to prudent investing for the long term.

Jessica Matthews, head of Cambridge’s Mission-related investing practice and a contributor to the report, said that the moment had passed when investors had the luxury of whether or not to take account of climate change. “That particular train has left the station,” she said. “It’s no longer a question of ‘whether’ to respond to the risks but ‘how.'”

The Playbook for Incorporating Climate Change Risk and Opportunity in Portfolios

To assist long-term investors in deciding how to respond to the risks apparent today, Cambridge has developed a “playbook” with a new framework including offensive and defensive strategies for considering climate change in long-term investment portfolios. In the report, Cambridge observes that investors may benefit from not only taking steps to measure and manage potential downside risks from climate change, but also identifying and capitalizing on growth areas as the world transitions into a lower-carbon economy.

“Our basic thesis is that the more challenging the problem, the greater the opportunity set for innovation, solutions, and ultimately, potentially attractive investment returns,” says Ma. This means “investors seeking to incorporate climate risk in their long-term decision-making may want to focus not just on defending against climate risk, but also on planning an offensive strategy to invest…in related solutions.”

The playbook for offense walks through five “opportunity themes:” renewable infrastructure, clean transportation, energy efficiency in buildings, water and agricultural efficiency, and “smart energy” — which includes connected power grids and energy-saving devices. From basic engagement with managers to proactive hedging instruments and even policy-level exclusion, the defensive playbook lays out actionable measures in various gradations of stance.

“We work with each client to implement an investment strategy tailored to individual needs and objectives,” says Philip Walton, head of Cambridge’s private client practice and contributor to the report. “Climate change risk is one of multiple environmental, social and governance factors that clients are increasingly looking at, particularly members of the younger generation.”

The Policy Response To Climate Change Is As Meaningful A Risk As The Ecological Impact

Cambridge says that the consequences of climate change — the long-term evolution of global and regional weather patterns driven by the rising level of greenhouse gas emissions — could be “dire.” Among other studies, it cites research from The Economist Intelligence Unit that puts the mean expected losses to the global stock of manageable assets — which amount to $143 trillion — at $4.2 trillion by the end of the century. That is equivalent to the total value of the world’s listed oil & gas companies, or Japan’s entire GDP. These economic costs can be driven by physical impacts from climate change such as sea level rise and extreme weather events, supply chain disruptions, and longer term effects on labor health and productivity.

Policy and regulatory activity can create a 'recoil' effect, where in the attempt to defend against and mitigate climate impact, that mitigation action itself can have economic repercussions. These repercussions can occur even if the ecologically-driven risks do not materialize

But the risks to investors are not just driven by ecological factors. The effects of policy or regulatory decisions could also impact investment portfolios. In the report, Cambridge notes that “[such decisions] can affect the long-term competitiveness and cost structures of many existing industries that are intricately linked within the current high-carbon global economy.”

“Policy and regulatory activity can create a ‘recoil’ effect, where in the attempt to defend against and mitigate climate impact, that mitigation action itself can have economic repercussions. These repercussions can occur even if the ecologically-driven risks do not materialize.”

As world leaders have just met in Paris and reached agreement on climate action, Mr. Ma warned that the “human responses to climate risks” can “become economic risks themselves.”

The discussions and agreement at the COP21 in Paris have set the stage for further ratcheting up of global policy and regulatory actions that could impose additional costs for high-carbon industries. Ma added that “investors would therefore benefit from staying ahead of the climate risk curve and be prepared to rethink their assumptions and position their portfolios accordingly.”

The Evolution of the “Resource Efficiency” Manager Universe

Cambridge Associates acknowledges that many investors may “find it hard to stomach investment opportunities” related to climate change because of their experience with the resource efficiency, sector in the mid-2000s. “The ‘clean tech’ sector comes with a tarnished track record, as the area is littered with failed companies and projects from the last boom and bust cycle leading up to and through the great recession.”

Yet closer inspection of the performance data shows that while the aggregate performance was disappointing, the performance of some sub-sectors demonstrates that opportunities do exist. As of March 2015, the gross internal rate of return (IRR) since inception for wind power manufacturing was -5.9% in Cambridge’s Clean Tech Company Performance Benchmark, which tracks over 200 marketable and private funds that focus on resource efficiency. By contrast, the IRR for energy storage, which attracted less investment, was 29.5%.

Many mangers active in the resource efficiency sector, especially those in private asset classes, are incorporating lessons learned from the past cycle and evolving their strategies. In the report, Cambridge identifies market signposts and manager characteristics, such as specialized domain expertise and networks, to be well positioned going forward.


About Cambridge Associates
Founded in 1973, Cambridge Associates is a provider of independent investment advice and research to institutional investors and private clients worldwide. Today the firm serves over 1,000 global investors and delivers a range of services, including investment advisory, outsourced investment solutions, research and tools (Research Navigator and Benchmark Calculator), and performance monitoring, across asset classes. Cambridge Associates has more than 1,100 employees serving its client base globally and maintains offices in Arlington, VA; Boston; Dallas; Menlo Park, CA; London; Singapore; Sydney; and Beijing. Cambridge Associates consists of five global investment consulting affiliates that are all under common ownership and control. For more information about Cambridge Associates, please
For informational purposes only; not intended to be investment advice. Any references to specific investments are for illustrative purposes only. The information herein does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. This release is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction. Past performance is not a guarantee of future returns.
For more information or to speak with Jessica Matthews, Philip Walton or Liqian Ma, please contact Eric Mosher, Sommerfield Communications at +1(212)-255-8386 or
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