Practical analysis for investment professionals
11 October 2016

Rising Sea Levels and a Falling Margin of Safety

“Investors’ personal views on climate science are irrelevant. Enough governments and businesses are convinced by the scientific consensus that the threat is real, and are driving regulatory and technological changes that are reshaping the investment landscape. You may not be interested in the climate, but you can be sure the climate is interested in you.” — Financial Times

Our changing climate is having real-world effects.*

Miami Beach, Florida, is experiencing increased flooding as a result of rising sea levels. All along the Eastern Seaboard in the United States, cities, towns — even naval bases — are battling an array of problems caused by increased coastal flooding and encroaching tides. Indeed, some scientists speculate that Manhattan — an island, by the way — could at some point find itself under water.

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The global climate has always been in flux. But historically changes have taken centuries, even millennia, to manifest themselves. We have not, as yet, ever confronted the sort of severe shift that current climatological models suggest may lay in store.

Investment managers need to be evidence-based, and the evidence is now very clear:

“’Once impacts become noticeable, they’re going to be upon you quickly,’ said William V. Sweet, a scientist with the National Oceanic and Atmospheric Administration, who is among the leaders in research on coastal inundation. ‘It’s not a hundred years off — it’s now.’”

Academic finance has started to research the issue. In “Price of Long-Run Temperature Shifts in Capital Markets,” Ravi Bansal, Dana Kiku, and Marcelo Ochoa examine the social costs of carbon emissions. They note that “temperature risks have a significant negative effect on wealth.” Each of the US equity portfolios they examine had a negative exposure, or beta, to long-run temperature fluctuations. This implies a rising risk-free rate and an equity-risk premium.

Many institutional investors now adjust for environmental, social, and governance (ESG) factors, and Morningstar recently began publishing ESG grades for the 20,000-plus funds it covers. While climate change is included among the 20-plus factors Morningstar grades, the phenomenon warrants a category of its own.

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BlackRock has also conducted climate change research. In “The Price of Climate Change: Global Warming’s Impact on Portfolios,” the authors discuss the potential influence changing carbon regulation could have on various industries. They note that the insurance sector has already begun to incorporate rising global temperatures into its pricing models. For the larger investment industry, however, the threat of global warming has yet to hit home:

“Most industries lag insurers when it comes to properly accounting for and pricing risks of climate-related events. Many equity investors ignore climate risk, and credit investors and ratings agencies do not routinely assess it. Property markets often ignore extreme weather risk, even in highly exposed coastal areas. Most asset owners do not measure their exposure to potentially stranded assets such as high-cost fossil fuel reserves that may have to be written off if their use is impaired by climate change regulation.”

BlackRock asserts that these effects are not currently priced, but will be very soon. Proactive investors should anticipate that. This is not to say that climate change’s impact will be uniformly bad. As with any wrenching change, there will also be opportunities along the way. Just as investors in fossil fuel-dependent companies must weigh the risks, investors in alternative energy or mitigation services companies could very well profit.

Though global warming could have devastating consequences worldwide, it does not mean investors should concentrate investments in landlocked, temperate nations. It does require that we carefully consider the phenomenon’s potential long-term effects. No part of the planet is immune and some regions will be more affected than others.

The real reason to diversify globally is not to avoid or mitigate short-term market blips, but rather to protect against economic catastrophes concentrated in our home markets, Clifford S. Asness, Roni Israelov, and John M. Liew observe. Investors should be especially mindful of this when it comes to climate change.

Ad tile for ESG and Responsible Institutional Investing Around the World: A Critical Review

The environment’s margin of safety is narrowing with each uptick in global temperatures. This will translate into greater effects on investor portfolios. It is the job of the investment manager to cushion against those risks while still seeking profitable opportunities.

I posed the following question in a recent blog post: “What idea in finance today, that we hold to be true, will seem laughable in 100 years?”

In a century’s time, it may very well be laughable that we did not take the risks of global warming more seriously when considering our investments.

You can read more from Tadas Viskanta on his blog Abnormal Returns or follow him on Twitter @abnormalreturns.

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* This post was written before Hurricane Matthew struck the Caribbean and the eastern United States.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

 Image credit: ©Getty Images/SeppFriedhuber

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About the Author(s)
Tadas Viskanta

Tadas Viskanta is the founder and editor of Abnormal Returns. He is also the author of Abnormal Returns: Winning Strategies from the Frontlines of the Investment Blogosphere, which culls lessons learned from his time blogging.

12 thoughts on “Rising Sea Levels and a Falling Margin of Safety”

  1. Chuck t says:

    Climatologists and financial analysts have a lot in common. They both have bad track records predicting the future. 100 years from now people will laugh at how we actually thought we can understand very complex systems that are beyond human capacity.

    1. Victor Kamendrowsky says:

      Chances are that 100 years from now people will cry, not laugh.

  2. Rick Lovely says:

    Years ago(the 80’s) a company I worked for went up on the ice off the coast of Greenland and drilled aprox. 250 feet down in the ice and retreved a WW 2 fighter plane that was one of 6 (if I remember right). the bombers were left behind also. They were known as the lost squadrin. They landed on the ice in the middle of a storm back in the 40s and were left there when the crew members were rescued.
    i often wonder if enough ice has melted yet so the rest have sank to the ocean floor or is anyone keeping track as to possibly retreve the rest of them when it gets a little more economicly feesible. the reason the rest of the planes were left behind was a cash shortage. I also remember the fighters being quite rare and in surprisingly good shape

  3. Mark T says:

    The original statement that it doesn’t matter whether you believe in Man made Climate Change because enough policy is being set on the back of that belief system is the only verifiable statement in this piece, the rest is opinion and speculation. The evidence is not, repeat not, very clear. It doesn’t matter how strongly you assert it, or how much pressure is brought to declare the science settled, this is now politics not science. There is a theory of AGW, there are facts that appear to support it and facts that appear to contradict it – including the fact that none of the models appear to have successfully predicted anything over the last 18 years, but that doesn’t matter because policy makers ‘believe’.
    I happen to believe that QE is ridiculous, but policy makers continue to apply it. Same with AGW, I don’t believe the opinions stated as truths (and distrust the near religious fervour) but to the extent that the lobbyists, crony capitalists, Big Green and others have hikjacked the debate to turn on a pipeleine of government subsidies I realise I am equally foolish to ignore the march of policy. As such I would sell stocks that will be penalised by government fiat, but I will buy a cheap Manahattan apartment from anyone that wants to sell on the speculative basis that the island will be under water.

    I think in 100 years time we will regard as laughable the false precision of climate models and indeed measurement. In terms of sea levels we are observing millimetre increases and extrapolating when we can’t even be sure if the sea is rising or the land is falling – a key measuring station is in Hong Kong for instance on reclaimed land! Equally the notion that we can measure the average temperature of the earth to a precision which does not even cover the average temperature within a single sitting room is ridiculous. A single measuring station covering millions of square miles of south America is responsible for a major proportion of ‘measured’ temperature increase for example. And how do we compare that over any meaningful period of time?

    1. gb says:

      No, the evidence is fairly overwhelming. Asserting that it is not does not make it so.

      But let’s skip the fact-finding part; plenty of more qualified individuals have already done that. The basic scientific principle of carbon dioxide as a greenhouse gas is unquestioned. The fact that the concentration of carbon dioxide in the air is increasing is also unquestioned. Therefore, the heat retention of the earth should be increasing. Why would it not? The base assumption in science is not to ignore what we already know about science.

      The models are imperfect, the data collection is imperfect, so the projection are imperfect. But an inability to forecast the precise manifestation of climate change does not invalidate the principle.

      1. Chuck T says:

        Go read Michael Creightons essay “Aliens caused global warming”. Referencing “qualified individuals” and stating that certain things are “unquestioned” is not scientific fact. That is quasi-science and closer to political oppinion. We cannot observe the complex systems that are beyond our capacity and we cannot predict the future which is pure randomness.

        1. RobJ says:

          Yes, Creighton’s essay is quasi-sicence and political opinion.

          1. Chuck t says:

            But, Creighton’s essay is not being used to rob the public through misguided government subsidies.

      2. Mark T says:

        No the base assumption about science is the scientific method. You start with a general theory, say greenhouse gases and heat retention, then you develop a hypothesis, in this case that the important greenhouse gas is actually carbon di-oxide and in particular man made Co2. You then develop a testable prediction or model so in this case a correlation between higher CO2 and global temperatures and then gather data to test those predictions. The (usual) process involves refining, changing, expanding or rejecting the hypothesis on the basis of the facts collected. In this case, the testable hypotheis has not been supported by the data collected, we can argue over exact measurements (and my point was the delusion that we can measure average global temperatures to a greater accuracy than we can measure the average temperature in my sitting room) but what really is undeniable (as opposed to your assertions that things are unquestioned) is that the predictions of the models over the last 18 years of AGM alarmism have simply not come to pass. Plot any of the forecasts against measured reality and the measured temperatures are simply, far, far below the predicted ones. It doesn’t matter how much the past data is ‘smoothed’ by UEA to make the back tests look good, or how much the previous data is revised down to give an upward slope, the scientific method requires us to refine, adjust, expand or reject the hypothesis on the basis of the data. But that doesn’t seem to happen here, instead we tend to get ad hom attacks for daring to suggest that the theory is less than perfect and that the trillions of $ spent in pursuit of this project could and should be better spent elsewhere (see Bjorn Lomberg in the WSJ this morning and passim). but as I said in my original post, it doesn’t matter what I believe, what matters is what policy makers are acting upon. As such it makes sense for me as an investor to place a greater risk premium on anything likely to suffer from adverse government policy based on lobbying from big green. Equally, I am prepared to buy anything that becomes cheap on the basis of the predictions of climate change models – such as anyone wanting to sell me a cheap flat in manhattan on the basis of Al Gore’s predictions on sea levels.

  4. Vince says:

    What a joke. This is a purely political statement. Leading with a quote from the Financial Times further lowers the credibility of the piece. Imagine explaining to a client why their portfolio tanked because you were shifting their allocation due to climate change. That is a quick way to get fired and then sued. Also, it fails to meet the fiduciary and ethical duty of putting a the interests of the client first. There are plenty of other places on the web for this kind of non-sense. This blog shouldn’t be one of them.

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