Thematic Investment Insights
Key Highlights:
- Physical climate risks are increasingly recognised as financially material, with global economic losses from natural disasters exceeding USD 4tn over the past 50 years.1 However, only 40 per cent of the USD 280bn in losses from natural catastrophes in 2023 were insured.2
- Asset managers have traditionally focused on transition risks, but the growing frequency and severity of physical risks demand enhanced research and integration into investment strategies. Both top-down and bottom-up approaches offer valuable insights for strategic asset allocation and security selection
- A “build or buy” dilemma exists in climate-risk modelling. While in-house models provide transparency and control, third-party solutions offer immediate insights. A hybrid approach, leveraging a continuum of modelling options, can tailor solutions to specific investors’ needs
1 - World Meteorological Organization, “Economic costs of weather-related disasters soars but early warnings save lives”, May 22, 2023.
2 - Swiss Re Institute, “Sigma, Natural catastrophes in 2023: gearing up for today’s and tomorrow’s weather risks”, No 1/2024.
Physical risks are financially material, but consensus on the impacts is lacking
Physical climate risks, such as natural disasters and extreme weather events, are increasingly recognised as a significant financial threat. Over the past 50 years, natural disasters have caused economic losses exceeding USD 4tn,1 with only 40 per cent of such losses insured in 2023.2 The financial burden of these risks is unevenly distributed, with lower-income countries experiencing disproportionately higher GDP losses. Despite the evident materiality, there is no consensus on the magnitude of future impacts, with projections ranging from catastrophic GDP losses to minimal effects. This uncertainty underscores the need for enhanced research and data capabilities to integrate physical risks into investment strategies effectively.
Transition risks have traditionally been the investment focus
Historically, asset managers have prioritised transition risks – those linked to regulatory, technological and market shifts in the move to a low-carbon economy – due to their immediacy and alignment with existing expertise. However, the increasing frequency and severity of physical climate risks are shifting the focus of concern. Unlike transition risks, physical risks require specialised datasets and expertise, including granular data on chronic and acute perils by location. This change demands that investors broaden their research capabilities to incorporate physical risks into their decision-making processes.
The build-or-buy dilemma in climate-risk modelling
Investors face a critical decision in addressing physical climate risks: whether to develop in-house models or rely on third-party solutions. In-house models provide transparency, control and the ability to tailor assumptions, but they require significant resources and expertise. Conversely, third-party solutions offer immediate insights but may lack flexibility and transparency. A hybrid approach, combining elements of both, allows these trade-offs to be balanced effectively. This continuum approach enables tailored strategies based on expertise, data budgets and client needs, ensuring that physical risks are considered in a practical and impactful manner.
1 - World Meteorological Organization, “Economic costs of weather-related disasters soars but early warnings save lives”, May 22, 2023.
2 - Swiss Re Institute, “Sigma, Natural catastrophes in 2023: gearing up for today’s and tomorrow’s weather risks”, No 1/2024.