Unhedgeable Risk: How climate change sentiment impacts investment
Short term shifts in market sentiment induced by awareness of future, as yet unrealised, climate risks could lead to economic shocks, causing substantial losses in financial portfolio value within timescales that are relevant to all investors. Factors, including climate change policy, technological change, asset stranding, weather events and longerterm physical impacts may lead to financial tipping points for which investors are not presently prepared. This research shows that changing asset allocations among various asset classes and regions, combined with investing in sectors exhibiting low climate risk, can offset only half of the negative impacts on financial portfolios brought about by climate change. Climate change thus entails "unhedgeable risk" for investment portfolios. While the response to action aimed at limiting warming below 2degC is shown to be negative in its short term economic and financial impacts, the benefits of early action lead to significantly higher economic growth rates and returns over the long run, especially when compared to a worst case scenario of inaction. The present study shows that certain types of portfolio benefit more than others. Even in the short run, the perception of climate change represents an aggregate risk driver that must be taken into consideration when assessing the performance of asset portfolios. Our analysis provides investors with a general guide to minimising their exposure to climate sentiment risk and has the potential to stimulate a constructive dialogue between investors, governments and regulators to examine the conditions necessary to build more resilient financial markets under unprecedented environmental change.