It’s Getting Hot Out There: Investors Need to Pay Attention
In a previous incarnation, I was a theoretical astrophysicist. In that role, I worked on a team that tried to parse how much of global warming could be attributed to the sun and how much to human causes.
As someone who worked directly with climate change data, I can assure you: Climate change is real. And even though I have been out of that business for about 20 years now, every year I see more evidence piling up.
Average Global Temperature Anomalies since 1880
Source: National Aeronautics and Space Administration (NASA)
Independent measurements by NASA, National Oceanic and Atmospheric Administration (NOAA), the UK Met Office, and the World Meteorological Organization (WMO) all confirm that 2017 was the third hottest year on record, trailing only 2015 and 2016, when El Niño led to a cyclical warming of the planet. In fact, 2017 had no El Niño effect but was significantly warmer than 1998, when a strong El Niño contributed to an extraordinarily hot year.
If annual global temperatures are corrected for the cyclical influence of El Niño and La Niña, 2017 was the hottest year on record. And hotter temperatures mean more energy in the atmosphere and that fuels more extreme weather phenomena.
This, in turn, has an increasing impact on investors. Munich Re recently published their estimates for losses caused by natural catastrophes in 2017. Total losses amounted to $330 billion, the second highest annual total after 2011, when the Tōhuko earthquake and tsunami in Japan exacted an enormous $354-billion toll.
Hurricanes Harvey, Maria, and Irma contributed to the costliest hurricane season ever last year, with $211 billion in losses — and Americans were lucky that Hurricane Irma dealt Florida only a glancing blow. Overall, insured losses amounted to $132 billion and many catastrophe (cat) bond funds suffered their worst years ever.
Performance of Select Catastrophe Bond Funds
Source: Bloomberg, Fidante Capital
In fact, more and more natural disasters are caused and strengthened by previous natural disasters. The heavy snow and rainfall in California in the winter of 2016–2017 caused significant new vegetation growth in the spring. When drought returned in summer, this newly grown flora provided extra fuel for the autumn wildfires. And once all that vegetation burned, the soil eroded and disastrous mudslides developed because the ground could not absorb the moisture once the winter rains started.
So investors need to take climate change into account — not just when considering investing in insurance-linked assets, but also when investing in other asset classes:
- Oceanfront property — particularly in Florida — is coming under graver and graver threat from rising sea levels, tropical storms, and hurricanes. This, in turn, affects property valuations and creates higher demand for inland properties.
- The insurance industry is finding it increasingly difficult to generate profits from flood insurance and other weather-related insurance policies. The losses from weather-related catastrophes are climbing at a faster pace than premiums can be raised. As a result, flood insurance and related products become loss makers.
- The security threat posed by climate change has earned greater acceptance in the United States and elsewhere. While the current administration in the United States is skeptical about the effects of climate change, the Pentagon is already preparing for the potential ramifications. So the defense and aerospace industry will have to adapt its products to address climate change risks.
Environmental, social, and governance (ESG) investing is no panacea for climate change because the damage to a company’s bottom line materializes whether the firm has a high ESG score or not. Analysts and investors need to address the risks of climate change with models based on traditional financial statement analysis.
Given insurance industry losses in 2017, such efforts are growing ever more critical to create added value.
For more from Joachim Klement, CFA, don’t miss Risk Profiling and Tolerance: Insights for the Private Wealth Manager, from the CFA Institute Research Foundation, and sign up for his regular commentary at Klement on Investing.
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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.
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