Climate risks are increasingly being taken into account for investment decisions, a study shows

Institutional investors consider climate risks as important investment risks and are increasingly taking them into account for their investment decisions, according to a study by GSEM Prof. Philipp Krüger, Prof. Zacharias Sautner (Frankfurt School of Finance & Management), and Prof. Laura Starks (University of Texas at Austin). Rightly so, as the authors emphasize that investors should consider climate risks.

"The Importance of Climate Risks for Institutional Investors" published in The Review of Financial Studies shows that institutional investors believe that climate risks have significant financial implications for portfolio firms. Further, the majority believes that such risks, especially those related to regulation, have already started to materialize.

“There is a growing recognition that investors should consider climate risks”, Professor Philipp Krüger says, while emphasizing that integrating climate risks into the investment process can prove to be challenging, with investment tools and best practices not yet well established. In fact, their study shows that while investors have already started to integrate climate risks, the industry as a whole is still at early stages of incorporating these risks into their investment processes.

By gaining a better understanding whether, why, and how institutional investors consider climate risks in their investment decisions, this analysis demonstrates that investors should consider climate risks. The authors hope that their findings help to spur additional theoretical and empirical research in the area.

Risks & opportunities

The study emphasizes that climate risks have potentially large effects on investors’ portfolio companies. Some companies face direct costs related to changes in the climate, originating from extreme weather events or a general rise in sea levels.

At the same time, climate change also provides investment opportunities for the portfolio companies and their institutional investors, for instance, in the areas of renewable energy or energy storage.

First steps toward managing climate risks

Most of the participants in the study have taken at least first steps toward managing climate risks, although the two most common approaches (analyses of carbon footprints and stranded asset risks) have been used by less than half of them. Divestment is the least frequently used approach overall.

This finding is interesting in light of the current debate about whether divestment or engagement is more effective in combating climate change.

Financial and nonfinancial motives

The study indicates that no single motive dominates the investors’ explanations for why they incorporate climate risks into their investment processes. The most common motives provided by the investors are to protect their reputations, moral/legal considerations, and the belief that climate risks affect portfolio risk and returns.

These findings imply that institutional investors consider climate risks both because of nonfinancial and financial reasons.

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