As Climate Risks Intensify, Investment Analysis Must Rise To The Challenge

Any successful asset manager needs to identify and analyze large systemic changes and the corresponding risks and opportunities they could bring. These types of changes are often driven by technological advances and/or regulation. We believe climate change represents a large systemic change set to have a material impact on investment performance across geographies and asset classes. Given the complexity of climate change dynamics, blending them into investment decision‑making requires not just the capacity to derive the data and insights, but also the systems and processes to integrate them into the analysis.

At T. Rowe Price Associates, Inc., our approach combines fundamental analysis (by analysts and portfolio managers), thematic and topical research (by in-house environmental, social, and governance (ESG) specialist teams), and our proprietary Responsible Investing Indicator Model (RIIM) analysis—which includes an assessment of issuers’ net zero status. It also integrates appropriate stewardship measures that seek to align with clients’ investment objectives.

Given its materiality to investment performance, climate factors and their level of materiality are considered across our investment platform; however, the investment implications can vary depending on the client’s mandate. Most of our clients have given us a mandate to deliver financial performance—in these cases, consideration of climate factors is for the purpose of delivering better financial performance. This requires insights into how corporate and other issuers may perform under a variety of climate-related scenarios, ranging from adherence to evolving regulatory demands to their capacity to conduct business in a changing environment. More specifically, this might include how they plan an orderly transition to net zero or how they are preparing for a hotter world where physical adaptation of business activities becomes necessary.

At the other end of the spectrum, a small but growing number of clients have dual mandates that include specific sustainable objectives alongside financial performance. Their sustainable objectives might include meeting net zero or greenhouse gas (GHG) reduction targets, excluding securities linked to fossil fuel production, or voting decisions that are not predominantly driven by financial materiality. In these cases, the analysis of climate factors will be the same, but the strategy may take a different approach to stewardship and divestment.

In both cases, our analysis of climate factors is benchmarked against a 1.5°C net zero pathway. To achieve this, the base case scenario implies a 50% reduction in greenhouse gas emissions by 2030 and achieving net zero by 2050. The pathway to net zero also must be science-based, which means that offsets can only be used for hard-to-abate emissions.

For many years, we have discussed data availability as a notable headwind to analyzing climate change-related risks and opportunities. The bottom line is that data remain lagged and underreported but have been improving steadily. To evaluate an issuer’s climate change exposure, an investor needs a mix of quantitative and qualitative inputs. We believe that the Task Force on Climate-Related Financial Disclosures (TCFD) reporting standard captures the required information very comprehensively, which is why we have long advocated that our investee companies adopt this reporting standard. TCFD standards have now been absorbed by the new International Sustainability Standards Board that is gaining support from regulators around the world.