If There Were a VIX for Weather, It Would Be Off the Charts

Climate change will be a blow to markets, but it’s not yet priced into all asset classes, securities, or countries, leaving opportunities for active managers.

Callaghan O'Hare/Bloomberg

Callaghan O’Hare/Bloomberg

Climate change is driving a wholesale repricing of assets and active managers have a once-in-a-generation opportunity to invest in a new set of winning asset classes, sectors, and countries while reducing the risks of holding the losers, according to a PGIM report.

“The next 10 to 15 years of climate change is already baked in,” said Taimur Hyat, chief operating officer for global asset manager PGIM, during an interview on the report, expected to be published Thursday. “If there were a VIX for climate change, it would be at an all-time high. The increasing volatility of weather makes it more certain that there will be more volatility in markets, and how will investors respond?”

PGIM argues that investors need to analyze their portfolio assuming that climate change is happening right now and the near future can’t be changed. “But over that period, there’s no need for investment paralysis,” added Hyat. PGIM manages public equity, public fixed income, private fixed income, real estate and alternative strategies for institutional and retail investors.

The asset manager argues that climate change lowers economic growth as a result of labor productivity declines and battles that will be fought over public and private resources to deal with emergencies and to build new infrastructure. But the impact won’t be evenly spread around the world, particularly in emerging markets. South Africa and Brazil, for example, face “high” climate risks, while South Korea and the Czech Republic face “low” risks, according to PGIM.

At the same time, the shift from fossil fuels to renewable energy will take far longer than most investors expect. PGIM also argues that climate change could result in even more catastrophic changes, such as a massive migration of people from hard-hit areas into more stable regions and more deadly diseases.


“The real question for investors is not if repricing of climate risks will occur, but when and how,” according to the report.

The report covers a number of catalysts that may set off a repricing of assets, including more data and research that will allow investors and others to do more detailed evaluations of the effects of things like rising temperatures; government policy changes; shifts in investor and consumer sentiment; and a new understanding of corporate liability.

Active investors have a number of investment opportunities, including in sovereign debt and U.S. municipal bonds, according to PGIM.

“We don’t think the impact is priced into the market. Look at Russia and India. They have the same credit ratings, but the impact of climate change will be much more severe in India. An active investor can get an edge there,” said Hyat. He emphasized that the impact of climate risk will be greatest on longer maturity debt.

PGIM also argues that possible investments include the most resilient properties in so-called brown industries, many of which have been left for dead; aging energy infrastructure that can be replaced with renewables in less crowded markets like Uruguay and Chile; and certain real estate.

Institutional investors hold disparate views on the impact of climate change on their portfolios. In a survey of institutional investors that is included in the PGIM report, 48 percent say that real estate poses an “investment risk” because of climate change, while 38 percent said it’s an opportunity. Forty-one percent responded that infrastructure poses a risk, while 67 percent saw it as an opportunity to invest.

One of the biggest positive changes for investors has been better and more available data.

“When it comes to analytics and data, there is more and more reliable ways of looking at climate risk in your portfolio,” Hyat said. “There are more vendors, the major credit ratings agencies have partnered with specialists and then the regulators are increasingly requesting that companies provide more data to investors.”

But fundamental researchers still need to be skeptical as the quality of information from third-parties can vary. “Data is just one input for the analyst. And you can’t just look at two or three metrics,” said Hyat.

Investors also need to be creative, using alternative data like updated flood maps or thinking about hidden risks such as pharmaceutical supply chains.

Severe changes are coming, but that doesn’t mean all green energy will provide a good payoff.

“Many emerging asset classes – such as green bonds, solar ABS, carbon emissions allowances and resiliency bonds – are still at a nascent stage and likely not fully viable for most institutional investors,” according to the report.

Still, Hyat argues, “too much of climate change investment literature is about integrating these changes into a risk model. Much less has been said about opportunities.”