Evaluating the Impact of Climate Change on Investments

How will climate change affect investments? Common sense says: Nothing good will happen. But when the serious environmental problems intensify, planet wide, how economically damaging would they be?

The deterioration of the environment will be a slow-motion process, with few sudden jolts likely, according to Riccardo Rebonato, an academic who studies risk management and its intersection with climate change, in an interview with Net Zero Investor, a London-based periodical. Rebonato, the former global head of rates and foreign exchange at asset manager PIMCO, is a professor of finance at France’s EDHEC Business School, and the scientific director of its Risk Climate Impact Institute.

“No Minsky Moment” will occur, said Rebonato, meaning a collapse in asset prices—a term associated with the late economist Hyman Minsky, who studied financial bubbles.

Rebonato declared that, with climate change, it “is difficult to conceive a particular event like Lehman Brothers that could trigger” an economic plunge as the collapse of that investment firm did in 2008.

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“What is more likely to happen is that, over time, actual earnings, actual cash flows, disappoint,” he said. “It is going to be a death by a thousand cuts.”

He did not quantify what that would entail, although others have. The economic damage from climate change may lead to a 19% slump in the global economy over the next 25 years, according to the scientific journal Nature.

That, he contended, means a steady erosion of stock prices would occur, but few now can see that, as the onset of any harsh effect from climate change seems far distant to most people. So right now, “Equity markets do not seem to reflect any substantial adjustment for climate change,” he remarked.

To Rebonato, a recurrent drip-drip-drip of bad corporate returns will eat away at equity markets. The progression, he explained, would be “serious, if not catastrophic,” leading to “continuously negative surprises.” And no market turnaround would appear to erase the damage, in his view: “When you have a big shock like Covid, you get a massive fall of equities, but then a rebound. Here, there is no mechanism for a rebound.”

Rebonato argued that his dire scenarios were not based on worst cases, as set out by the Intergovernmental Panel on Climate Change, a United Nations body that formulated several possible outcomes for the environment as the planet warms, from relatively mild to truly horrible. Still, even moderate scenarios would harm stocks and other investments, Rebonato stated.

Government payments to try to offset climate change’s impact would be expensive, he admonished, with either higher taxes or increased public debt footing the bill. If greater government borrowing is the predominant path, that would lead to lower interest rates—ordinarily a plus for stock valuations. Trouble is, he added, amped-up inflation could also result, which would harm both stock and bond investors.

Nonetheless, combating climate change would be a business opportunity for some that could benefit investors, Rebonato acknowledged. At this stage, though, the fortunate businesses are difficult to pinpoint: “You might get the clever person who has picked the right sectors. Good for her; she is cleverer than me.”