How climate change will affect the return on your investments

The latest edition of Nordea’s “ESG Investments” series focuses on the implications of climate change for investors. Keen to know what the future might hold, we caught up with Head of Investments, Kerstin Lysholm, to run through some of the key questions.

The first question is perhaps the most basic: what do investors need to know about climate change?

"Our message to investors is this: climate change will likely affect long-term investment returns. While it’s not possible to say how big the impact will be, we’re confident that the link is there: temperature increases and measures taken to limit global heating will translate into lower returns on at least some assets, including stocks and bonds. This is something that investors should take into account in their long-term investment planning."

How does climate change affect investment returns?

"Put simply, climate change leads to conditions under which economies are less productive – and productivity growth is a key driver of economic growth, which drives the expected return on many financial assets."

So climate change = lower productivity = lower economic growth = lower investment returns?

"To some extent, yes. Consider increasing temperatures: in general, the labour force tends to become less productive in a warmer environment. Higher temperatures also increase the likelihood of extreme weather events, which disrupt production and infrastructure, lowering productivity. Then there’s the cost of mitigating actions – necessary actions to limit further temperature increases. Lowering carbon emissions will, to some degree, entail at least a temporary drop in productivity. In any given economy, lower productivity means less wealth being generated, which is sooner or later reflected in lower investment returns."

You say “to some extent”: are all regions equally affected?

"Our analysis suggests climate change will affect different countries and regions differently. For example, temperature increases will have a greater impact on productivity in countries with relatively high current mean temperatures (above 15°C); at the same time we know that temperatures are increasing faster in the Nordic region compared with the global average.  We also foresee economies with high carbon-intensive production and/or significant fossil fuel reserves being more affected: the cost of transitioning to a low-carbon economy will be higher for these countries, and any fossil fuel reserves will fall in value as new, cleaner technologies are phased in.

What is the outlook for the Nordic countries?

As long as global temperatures are limited to around 1,5-2°C above pre-industrial levels, the Nordic countries should be relatively less affected. The costs of transitioning to a low-carbon economy will also generally be lower for these countries.

How soon can we expect the impact of climate change on investment returns to materialise?

The effects of climate change come with a considerable time lag, which makes it difficult to form clear expectations. One area of uncertainty concerns how different governments will approach the challenge of transitioning to a low-carbon economy. Something like a carbon tax has the potential to drive down productivity and economic growth. But this depends on the size of the tax and how the revenues are used. They could be used in such a way as to minimise the distortionary effect on the economy. For example, they could be used to support the development of new technology, enabling businesses to implement it in a less costly way, or to compensate households for higher energy prices.

What is your advice for investors?

First of all, it’s important to point out that our analysis, like any other, is based on assumptions – it’s how we have chosen to start our own thinking around these issues. But we hope it inspires investors to think about them, too, and incorporate this thinking into their long-term strategic investment planning.

Nordea has set the climate goal to reach net-zero emissions latest 2050 – here you can read more about sustainability at Nordea