Institutional Investors Find Alpha in Climate Risk Matrices: Global Survey Finds

The Task Force on Climate-Related Financial Disclosures advises that climate change and extreme weather risk should factor into institutional portfolio management, founded on studies confirming that (1) climate change and extreme weather risk are effectively irreversible, and (2) the consequent impacts (largely negative) of climate change could potentially extend across all business sectors and geographic domains.

The need to factor climate risk into portfolio management is clear – the outstanding challenge is “how?” Unfortunately, there is no standardized guidance regarding means to include physical climate risk into institutional portfolio management.

In response, this paper presents Climate Risk Matrices as a practical tool for institutional investors to integrate physical climate risk into portfolio management. In brief, a Climate Risk Matrix identifies the top 1-2 means by which extreme weather events (e.g., flood, fire, extreme heat, etc.) may negatively impact a specific industry sector, while identifying actions that a company within that sector could be expected to take to mitigate these risks.

The paper further describes results of an international survey focused on understanding the methods undertaken by portfolio managers to assess physical climate risk, the extent of formal training on physical climate risk received by the Boards of Directors, C-Suite officers and portfolio managers, and the utility of Climate Risk Matrices to aid portfolio managers in investment decisions.

The survey results confirm the need to improve translation of physical climate risk into financial valuations, while highlighting the utility of Climate Risk Matrices as a practical tool, consistent with TCFD, for application of climate risk assessment into portfolio management. The survey results also illustrate the need for scaling formal training on climate risk among Boards of Directors, C-Suite officers and portfolio managers.