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How Climate Change Affects Stocks & Bonds

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Climate change is big news — both bad and good — for long-term investors, according to a recent report from Nuveen.

“The bad news? The longer your time horizon, the more climate change risk is compounding. The good news? Effectively managing your exposure can help add alpha and manage risk,” the report states.

Stephen Liberatore, lead portfolio manager for TIAA Investments’ responsible investing fixed income mandates at Nuveen, talked to ThinkAdvisor about how important climate change has become to investors.

“One of the things that most people have started to recognize and acknowledge is that climate change as an issue is not so much about only saving the environment or improving the environment,” he said. “There’s a material financial risk to not doing it.”

For example, Liberatore described how insurance companies are “obviously very keen and very much focused” on climate risk because that is a potential risk for them in what they’ll insure and how they insure it.

“You will see how all companies now have to be focused on the impacts of climate change because it will influence where they put a facility or where they will build or expend [capital], because if it’s in an area that maybe is more prone to hurricanes or floods or landslides you’re not going to put a facility there,” Liberatore explained.

In Nuveen’s view, addressing climate change risk is critical to adding alpha while reducing risks and avoiding catastrophes — in every asset class that adopts a long-term view.

In particular, here are Nuveen’s views on how climate change can affect stocks and bonds.

Public Equities

Companies that successfully account for the impact of climate change have the potential to perform in line with — or better than — their peers, according to Martin Kremenstein, head of retirement products and exchange-traded funds at Nuveen.

For example, he writes in the report that the MSCI Low Carbon Target Index modestly outperformed the MSCI ACWI since 2010.

Looking ahead, climate-related risk is predicted to compound over time. Kremenstein writes that this means that “climate-attuned portfolios have the potential to outperform amid tighter regulations, faster technological changes or more frequent catastrophic weather events.”

According to Kremenstein, companies may be able to generate added value for shareholders by offering solutions that meet the needs of a low-carbon economy.

In the utilities sector, for example, electricity generators have the potential to reduce greenhouse gas emissions and add alpha by increasing the use of renewables. Renewable energy costs have rapidly been declining, achieving parity with fossil fuel costs in many markets, according to the report.

Companies that proactively manage their exposure to climate change risks demonstrate stronger governance, and serve investor interests by mitigating costs that may address wide-ranging climate impacts, according to Kremenstein. Meanwhile, for companies that have failed to adequately manage these risks, the repercussions have been severe.

As an example, Kremenstein points to carmaker Volkswagen’s recent scandal.

“After admitting to cheating on auto emissions tests, they faced a recall of millions of vehicles, their CEO was forced to resign, and Audi’s CEO was arrested,” Kremenstein writes. “For several years, MSCI had already been flagging Volkswagen’s declining governance scores based on a number of controversies. Volkswagen was dropped from the MSCI ACWI ESG Index in May 2015.”

Public Fixed Income

Meanwhile, Liberatore writes in the report about how the green bond market has grown rapidly over the last 10 years.

While there’s been a shift in federal energy priorities, according to Liberatore, state and local governments, international agencies and private corporations are driving momentum toward a low-carbon economy with capital raised in the fixed income market.

Green bonds — as this funding mechanism is called — provide investment opportunities that offer the potential to achieve a “double bottom line” of competitive financial returns along with direct and measurable environmental benefits, Liberatore writes.

The green bond market has grown rapidly since its first issuance in 2007. According to Liberatore, the market remained concentrated by issuer type and use of proceeds in the early years, but issuance and diversification has since grown exponentially.

The labeled green bond market, which includes issues that meet specific industry conventions and/or receive third-party certifications, has grown to $452.9 billion and has rapidly diversified.

In addition, the unlabeled green bond universe — in which proceeds used for climate-aligned projects and initiatives but are issued without formal certifications — is estimated at roughly three times the size of the labeled market.

“This expansive universe, combined with our pioneering work with issuers, underwriters and industry groups, affords us a unique opportunity to align our investors’ bond holdings with their principles,” writes Liberatore.

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