Reconciling climate risk and fi nancial performance

LBP AM chief investment officer Guillaume Lasserre dispels the notion that investing in the climate transition will negatively impact performance

Shrinking fi nancial performance is a persistent fear among some asset man-agers wary of investing in the climate transition. Guillaume Lasserre, chief investment offi  cer at French asset man-ager and sustainable fi nance specialist LBP AM, describes why the opposite is true: investing in the climate transition would preserve fi nancial performance over the long term.

Where is conversation at on investing in the climate transition and the risk to fi nancial performance? 

The idea that performance must be sac-rifi ced to fi nance the climate transition is outdated. As the sustainable fi nance market matures and industries embark on their transition journeys, investors may witness some short-term surprises that undercut fi nancial performance. Historically, however, it’s hard to pin-point any clear link between climate transition costs and underperformance when you look at the data. There’s no major pattern. 

However, the impact of climate change is clear, most recently this summer with heatwaves, wildfi res and droughts across Europe. Long term, there will be a huge fi nancial cost to economies and investors not taking any action. A simple, immediate example is the cost to business of historically low water levels in Germany’s Rhine River due to extreme heat. The drought this summer has disrupted shipping and pushed businesses to use other, more expensive ways to transport goods, such as trains and trucks. And as climate impacts become obvious, we’re seeing investor focus shift from climate miti-gation to climate adaption in response to changing business behaviours.

What should investors think about when incorporating climate risk into investment decisions?

The fi rst consideration is transition risk and the possibility that a high-emitting business will not be able to adapt. Any ability to change depends on future management behaviours and decisions, and those are difficult to evaluate. So, we have developed proprietary indica-tors that track progress against a com-pany’s transition plan: the Transition plan scoring (TPS).

The second headline risk is physical. Where are the business’s assets located and how exposed are they to climate events? What impact does that have on a business’s viability and financial risk? There are good data providers out there that supply assessments on physical climate risk.

How does your risk assessment differ across assets?

By modelling business performance, it’s relatively easy to understand the impact of the climate transition on the financial performance of equities. With credit assets, it’s much more difficult. We’re not there yet with incorporat-ing climate risk into the capacity and solvency of a business. Climate change clearly effects financial performance, but we lack a framework to make a credit assessment that includes scenar-ios for how different climate impacts could prompt a default.

Given current macroeconomic and geopolitical volatility, where do climate issues sit in terms of investor priorities?

These topics are interconnected. Political and economic priorities may change in response to volatility, but climate change is an ongoing phenom-enon that will impact financial perfor-mance over the long term. We’re wit-nessing a shift toward deglobalisation and a move toward greater sovereign capacity for individual economies. The question then, is whether managing climate risk and decarbonisation is important to each economy. And the answer is, yes. 

An example of how this trend has impacted the way we invest is in the use of macroeconomic indicators. A year ago, we used the price of a barrel of oil as our sole energy indicator. Today, we observe that for economies that have started to transition away from oil toward gas as their major source of energy, measuring electricity prices could be as relevant as the oil price. 

For those economies, the price of gas is as important as the oil’s one since it is pushing up electricity prices, driving inflation and reshaping our long-term assessment. Due to the energy transi-tion, new, local sensitivities will arise. Oil is no longer the benchmark. We need to review a broader, more complex range of increasingly precise data to make informed investment decisions. 

How do you distinguish between companies  that are preparing to meet  the challenges of the climate transition and those just talking about it?

What is the ideal climate transition model comprised of?

One that would allow us to make a relative assessment between companies by incorporating everything from its balance sheet to its debt position, as well as physical climate and transition risk, and climate-related opportunities. Such a model would translate that assessment into price to identify what’s over- and underpriced. There are some indicators out there already, such as value-at-risk and its impact on the P&L, but it’s still oversimplified.

Looking forward, what will drive financial performance in relation to climate-related issues?

Capacity to transition is key, including the emergence of stranded assets. Is the contribution of these assets to current valuations significant? In future, this is likely to drop to zero. What steps can a business take to reduce physical risk, which is well understood by investors, but not fully materialised yet? 

To make these assessments, inves-tors require precise information to discern specific impacts on individual businesses, which may be located in the same country and subject to the same regulatory environment and macroeco-nomic conditions, but operate in places with very different climate-risk profiles.

As a result, demand for increasingly large and detailed datasets, reports and other information is rising. The good news is the evolution of artificial intelligence and large language models means asset managers can ingest high volumes of data to model impacts, which is changing how we approach portfolio management.