How asset managers are assessing physical risks amid extreme weather

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Eastern Canada and much of the U.S. recently experienced what weather experts refer to as a “heat dome,” with temperatures feeling hotter than 40 degrees with the humidex. While weather events such as these can cause physical discomfort for many, they can also affect the economy, investments and how risk is assessed in portfolios.
Known as physical risks, these more frequent and severe weather events around the globe are affecting physical assets and investments, with a cascading effect on some less obvious sectors.
Many fund managers have been considering environmental impacts on their investments for years. But the increased frequency of extreme weather events has pushed some to step up their risk assessments.
Nalini Feuilloley, head of responsible investment at BMO Global Asset Management in Toronto, says asset managers are considering physical risks less as a longer-term theme “being discussed from a research and an insights perspective, and we’ve moved into understanding the materiality of some of these developments in real-time.”
She explains physical risk from climate change is still not a metric unto itself but part of most portfolio managers’ “event-driven” category. These are “qualitative real-time developments,” meaning money managers are assessing the risks happening today and not only from an environmental, social and governance (ESG) perspective.
“It’s very much being incorporated in terms of how holdings are weighted or how decisions are made on portfolios in the same way any other event-driven risk would be considered,” she says.
Canada is particularly susceptible to physical risks as studies show that climate change is happening here at twice the rate it’s occurring globally.
Marie-Justine Labelle, head of responsible investing at Desjardins Group, says that affects investors in two ways: top-down, which is the physical risks affecting the economy as a whole, and bottom-up, which is the impact each sector would experience based on exposure to climate events.
“If you look at it top-down, and you’re an investor that’s more generally invested in the economy, then your portfolio, as a whole, has that risk,” she says.
From the bottom-up, some sectors such as construction and housing are affected more by the physical risks of climate change. But even industries that are not necessarily top of mind concerning climate impacts are taking a hit. A study from KPMG LLP published in October showed that six in 10 Canadian small- and medium-sized companies were affected by extreme weather in 2023.
“People often think about energy and utilities, and that’s true, but financial services is a big one,” Ms. Labelle says.
There’s “chronic physical climate risk” in mortgage lending, she says, with regions “where banks would have mortgages that become less and less insurable from a commercial standpoint.”
Ms. Feuilloley adds that many companies face physical risks in their supply chains, leaving few (if any) sectors unaffected.
“It could be low water levels that are impacting the transport of goods in a way that it’s really setting a lot of sectors back,” she says.
Low water levels in the Panama Canal affected global shipping last year, although scientists attributed the low rainfall to the El Niño climate phenomenon and not to climate change.
It’s not just the public markets looking long and hard at the risks of climate events happening right now.
Brian Kernohan, chief sustainability officer for private markets at Manulife Investment Management in Boston, says the way risk is assessed for his clients, particularly in the real assets space, has become intertwined with physical climate risk.
“It’s the norm these days that this type of assessment needs to happen,” he says. “Our clients are primarily institutional investment managers in private assets and the vast majority, if not all, have expectations that we as a manager will have assessment risks – transition and physical – and be able to demonstrate a competency to mitigate those risks, full stop.”
Many private market assets – such as farmland, agriculture and commercial real estate – are physical assets vulnerable to extreme weather events. Geographical location becomes an important part of the investment equation.
“If a wildfire starts and affects an invested forest, you could lose the forest. We have to understand where that happens,” Mr. Kernohan says. “In agriculture, it’s the risk of less water due to climate change. Do you have enough water to grow the crops the investment is predicated on? That built-in natural environment, that physical risk, becomes really acute.”
And just like the weather, he says, these assessments will evolve. “It’s not a one-and-done.”
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