Mapping climate risk for more resilient portfolios

Apr 20, 2022

From droughts and wildfires to storms and flooding, our health, lives, and livelihoods increasingly are subject to adverse climate events. As the world continues to reckon with climate change, two types of climate risk have emerged: transition risk and physical risk. Transition risk focuses on the effect of companies on the environment. Investment research within this area focuses on the risks and opportunities arising from the transition to a lower carbon global economy.

In contrast, physical risk is the effect of the environment on companies and economies more broadly. This includes the economic costs and opportunities that severe weather events can produce for economies, companies and ultimately, the communities and geographies tied to them. An investor may feel far away from a wildfire raging through another corner of the world, but our research shows that events like droughts, floods and storms affect economic activity, and businesses large and small—the health of workers, revenues, bottom lines, share prices and growth prospects. However, understanding climate events and their potential impacts may allow us to build more resilient portfolios and generate alpha.

The key is to have the right information. In the last few years, we have built a platform that processes terabytes of geospatial data, including snapshots of the Earth’s surface across many dimensions, including temperature, wind, precipitation, and cloud cover converted into interpretable quantitative impulses, from which we can learn about climate conditions, economic activity, and company performance over various time horizons. For instance, the National Aeronautics and Space Administration (NASA) has data on surface temperatures that can tell us about how excess extreme heat and cold conditions are impacting various parts of the world. The Federal Emergency Management Agency (FEMA) has information on natural disasters that can lead to understanding the damage and recovery efforts that are ongoing across the United States.

Snapshots of the Earth’s surface can be converted into interpretable data


Source: BlackRock with data from NASA, as of April 2022. For illustrative purposes only.

We’ve found that incorporating the data we find in these reams of publicly available geospatial reports with data on regional economic conditions or a company’s physical assets can unlock unique insights. With this lens, we seek to answer the following question: given the climate events currently happening around the globe, how should we adjust our portfolios to deliver more resilient investment outcomes?

For instance, our research shows that over longer time periods, oceanic oscillations—fluctuations in air pressure and sea-level temperatures—can lead to intense weather variation across countries causing significant disruptions to asset returns in emerging markets. So when allocating in portfolios on a country or regional level, we incorporate that geospatial information alongside other traditional economic or financial inputs.

Separately, we’ve observed that abnormal temperatures—when it’s either extremely hot or cold relative to seasonal norms—depress productivity in climate-exposed industries like construction and agriculture across developed markets. Such unusually high or low thermometer readings also tend to delay spending by consumers on discretionary in-person services industries, like outdoor leisure and restaurants.

Insights like these can help to inform positioning in our investment portfolios, including the BlackRock Sustainable Balanced Fund. We have also applied this work to help our local communities understand the economic impacts of climate change and weather events. In partnership with the California Resilience Challenge, we have found that severe weather has disproportionately affected counties with lower than-average income levels. This finding can help to direct adaptation and resilience funding to communities that need it most. Learn more about this work here.

Michael Pensky, CFA
Global Tactical Asset Allocation Team, portfolio manager for BlackRock Sustainable Balanced Fund
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Joshua Kazdin, CFA
BlackRock Systematic Active Equity Team
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