As Climate Change Gets Hyperphysical, Investors Should Too

29 October 2024

6 min read

Sara Rosner| Director—Responsible Investing Research

Markus Schneider| Senior Economist—EEMEA

Patrick O'Connell, CFA| Director—Fixed Income Responsible Investing Research

Integrating the physical toll of climate change helps investors spot key risks—and opportunities.

Climate-focused investing traditionally emphasizes how well industries are transitioning to low-carbon economies, such as responding to climate-friendly regulations, greener technologies and shifting consumer needs. But transition risks and opportunities are just one of several lenses to assess climate change’s impact on the investment landscape. Physical risks and opportunities are another.

Knowing Physical Threats Enhances Risk Assessment

The number of companies that acknowledge climate change’s direct financial impact grew 24% in 2023, according to a CDP Worldwide survey. But transition risks continue to command more of companies’ attention than physical risks. Between 2009 and 2020, for example, average mentions of transition risks in 10-K filings grew from four to 10, while average mentions of physical risks rose from two to just four, based on a Brookings Institute analysis. We think such low reporting for physical risks suggests that businesses are only beginning to appreciate their effect on the bottom line.

The threats are very real, however. Physical risks can be chronic—as with rising global temperatures and sea levels—or acute, as in the case of an extreme heatwave or a hurricane. Any of these can levy substantial financial burdens on businesses and global economic growth alike.

The financial toll of physical risks manifests in several ways, but often through local property damage or total loss. There are also costs for stranded or delayed production capacity, plant closures, supply chain disruptions and legal liabilities from not adapting assets and communities to be more resilient.

Disasters can also hurt local households, from job losses to residential displacement, which has implications for labor supply and customer demand for products and services. As these local extremes add up, their macro implications can throttle global productivity, trade and government revenues, as well as sway inflation and interest rates.

Physical Risks Won’t Disappear, Prompting More Ways to Cope

As a global disruptor, climate change remains one of a handful of mega-forces likely to permanently change how the world lives, works and consumes—all directly affecting countries, assets and companies on many levels.

For example, population centers will likely shift within countries and across continents as crops fail or it becomes too hot to work outdoors. Agriculture-dependent regions could be the most vulnerable, not only to food scarcity but to modern slavery.

Emerging-market (EM) regions are especially vulnerable to physical risks—frequently the result of flooding or drought. Thankfully, we’re seeing governments and the private sector deploying more coping mechanisms across these regions. These include adaptation plans, multi-hazard warning systems and risk assessments, which we believe help offset some of EM’s high exposure to physical risk (Display). This suggests that even countries with high physical-risk potential could take effective steps to manage it—and improve creditworthiness.

EM Physical Risks and Coping Capacity

Some EM countries show higher risk potential, which is in some regions offset by initiatives to cope.

Historical analysis does not guarantee future results.
Coping capacity measures a country’s ability to prepare, respond or recover from the effects of climate-related hazards on its infrastructure, residents and physical environment.
As of March 2024
Source: European Commission Disaster Risk Management Knowledge Centre, Haver Analytics and AllianceBernstein (AB)

Data Show Climate Change Is Global but Impact Is Local

Florida hurricanes, Canadian wildfires, Abu Dhabi flooding—when hazards strike, they’re not only more frequent and costly but also hyper-regional. That’s why we believe that understanding physical risks at the local level helps investors better assess their potential financial damage, even for globe-spanning entities.

Obtaining local physical-risk data can be challenging. In the US, some granularity can be mapped using the Natural Hazards Index (NHI), which AB developed in partnership with the Columbia Climate School. The index tracks 14 types of extreme-weather disasters and assigns risk scores to some 75,000 underlying census tracts. Meanwhile, the global Aqueduct Water Risk Atlas, which tracks potential water-specific risks, pinpoints areas facing the highest risks to potable water quality and quantity.

Another hurdle in evaluating physical risks is tying them to companies’ physical locations, since they tend not to be uniformly disclosed. However, Climate TRACE (Tracking Real-time Atmospheric Carbon Emissions) is making headway, offering models to help investors identify which of a global firm’s locations are high emitters. Combined with Aqueduct Water Risk Atlas data, the results can effectively map where a global company’s local physical risks are greatest (Display). Many leading data sources, such as Moody’s, S&P and MSCI, also now offer physical risk-scenario analysis tools—although sometimes with conflicting insights that require careful assessment.

Mapping a Global Company’s Physical Risks on a Local Level

Climate TRACE and Aqueduct Data Reveal Which of a Large Automaker’s Factories and Other Facilities Are Most Exposed

TRACE and Aqueduct data can show which automaker’s facilities worldwide are the most risk of physical threats.

For illustrative purposes only.
Source: World Resources Institute and AB

Engaging* directly with companies can also reveal much about their physical risk exposures and plans to address them. Engagement involves meeting with leaders, touring facilities and participating in shareholder meetings, among other activities. In many cases, more intel can be gained from dialogue than from data, especially when physical climate-risk reporting is still relatively new for many companies. This was the case with a large South American bank, whose most significant financial threat comes from—of all things—farming.

Banking on Agriculture: A Study in Physical Risk

The bank is a majority state-owned enterprise based in Brazil, the world’s largest agricultural exporter. About 85% of the nation’s farms comprise small family-owned homesteads that subsist on loans for which the institution is a top provider.

The bank’s primary physical risk exposure stems from the country’s epic regional flooding and drought. Both can disrupt farm production and upend the livelihood of its largest borrower group, who could be more likely to skip payments or default. The bank is also exposed through its insurance affiliate, which offers crop insurance, using farmers’ equipment and cash flows as collateral. Add in potential physical damage to branch locations and office equipment in the danger zones, and the picture looks grim.

A bank this large and with inherent government backing should have the resources to manage such risks and pursue the opportunities we see for it. Through our engagement with the bank, for example, we discovered helpful mitigation measures underway, such as spreading the insurance liability to willing participants in-country and abroad and more diversification across agricultural regions and crop types (Display).

As Local Agriculture Struggles, a State-Owned Bank Weighs Its Options

Risks to the bank include operational, direct and indirect, but opportunities lie in insurance, adaptation and diversification.

Historical analysis does not guarantee future results.
As of March 2024
Source: AB

We think inviting more government input and along with helpful solutions is another opportunity and should be in both the bank’s and the country’s interests, considering that agriculture represented about 24% of Brazil’s GDP in 2023.

The takeaway: physical risks can touch any industry in unique ways, but how companies respond can create opportunities that are just as unique.

Catastrophic and costly weather events continue to turn up the dial on physical and economic damage, creating life-altering disruption to people and property in every region. That’s why we believe that investors should seek opportunities stemming from the preparation, response and recovery surrounding climate-related hazards.

A growing number of relevant data sources, combined with engagement and an active investment approach, are especially helpful in this nascent area. Together, they can offer climate-focused investors effective tools to not only assess physical risks but also their potential effect on asset prices across regions, sectors, industries and companies of all stripes.

_{*AB engages issuers when it believes the engagement is in the best financial interest of its clients.}

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 revision over time.

About the Authors

Sara Rosner

Sara Rosner is a Senior Vice President and AB’s Director of Responsible Investing Research. In this role, she collaborates with investors across the firm to lead thematic research on material ESG issues. She also manages the development of training and programming on issues related to responsible investing, focusing on enhancing investors’ ability to integrate material environmental, social and governance considerations into their decision-making and investment processes. Rosner has created and implemented AB’s Climate Transition Alignment Framework. She co-chaired the firm’s working groups on the energy transition, ESG research and biodiversity, managing firmwide initiatives on climate scenario analysis, carbon offsets and ESG education and training. Prior to joining the firm in 2018, Rosner performed research for the Columbia Center on Sustainable Investment, where she worked on projects related to the United Nations Sustainable Development Goals and renewable energy alternatives in the extractive industry. She spent most of her early career as a journalist covering energy and infrastructure finance in the Americas for Euromoney Institutional Investor. Rosner holds a BS in international studies (magna cum laude) from Pepperdine University and an MS in sustainability management from Columbia University. She is a global member of 100 Women in Finance and a financial literacy volunteer. Rosner was named one of Crain’s New York Business Notable Leaders in Sustainability 2023. Location: New York

Markus Schneider

Markus Schneider joined AB in 2015 as a Senior Economist, focusing on macroeconomic analysis and bond market strategy for the EEMEA region. He has 10 years of in-depth experience covering emerging markets, and a background in econometric modeling-in particular, in its application for forecasting macro variables and emerging-market (EM) asset prices. Prior to joining AB, Schneider served as an EM economist and strategist for five years at Rogge Global Partners in London, and held similar positions at UBA Capital and Business Monitor International between 2006 and 2009. He holds a BA in economics and politics from Lancaster University and an MSc in economic development management from the London School of Economics and Political Science. Location: London

Patrick O'Connell, CFA

Patrick O'Connell is a Senior Vice President and Director of Fixed Income Responsible Investing Research. In this role, he is part of the leadership team that develops responsible investment strategy across AB's Fixed Income business, particularly related to integrating environmental, social and governance considerations throughout the team's research and engagement. Previously, O'Connell served as a corporate credit research analyst, focusing on emerging-market corporates in Latin American and African countries. He joined the Emerging Markets research team in 2013 after working as a credit analyst covering US high-yield energy credits at AB. Prior to joining the firm in 2012, O'Connell was a desk analyst at UBS Investment Bank, where he helped to allocate capital on the trading desk. He holds a BS in accounting and finance (magna cum laude) from Villanova University and is a CFA charterholder. Location: New York

This information is for exclusive use of the wholesale person to whom it is provided and is not to be relied upon by any other person. It is not intended for retail or public use and may not be further distributed without prior written consent of ABAL.
This webpage has been prepared by AllianceBernstein Australia Limited (“ABAL”)—ABN 53 095 022 718, AFSL 230 698. Information in this webpage is only intended for persons that qualify as “wholesale clients,” as defined by the Corporations Act 2001, and is not to be construed as advice. This webpage is provided solely for informational purposes and is not an offer to buy or sell securities. The information, forecasts and opinions set forth in this webpage have not been prepared for any recipient’s specific investment objectives, financial situation or particular needs. Neither this webpage nor the information contained in it are intended to take the place of professional advice.
You should not take action on specific issues based on the information contained in this webpage without first obtaining professional advice. Past performance does not guarantee future results. Projections, although based on current information, may not be realized. Information, forecasts and opinions can change without notice and ABAL does not guarantee the accuracy of the information at any particular time. Although care has been exercised in compiling the information contained in this webpage, ABAL does not warrant that this webpage is free from errors, inaccuracies or omissions. ABAL disclaims any liability for damage or loss arising from reliance upon any matter contained in this webpage except for statutory liability which cannot be excluded.
No reproduction of the materials on this webpage may be made without the express written permission of ABAL. This information is provided for persons in Australia only and is not being provided for the use of any person who is in any other country.

As Climate Change Gets Hyperphysical, Investors Should Too

Knowing Physical Threats Enhances Risk Assessment

Physical Risks Won’t Disappear, Prompting More Ways to Cope

Data Show Climate Change Is Global but Impact Is Local

Banking on Agriculture: A Study in Physical Risk

More For You