There is no place for an investor to hide when global warming comes knocking in its full glory, is the conclusion of a new academic study out of the University of Cambridge. In a report aptly titled “Unhedgeable Risk: How climate change sentiment impacts investment,” researchers claim investment portfolios could witness 45 percent of their value vanish by 2020 due to climate change. There are hedging solutions for near 50 percent of a portfolio, but understanding what and how to hedge depends in part on government action — or inaction — on the issue.

No investor is immune from risks associated with climate change

The common institutional investment portfolio with 60 percent exposure to stocks, 35 percent invested in fixed income and 5 percent in commodities will lose 45 percent of its value in a “no mitigation” scenario where the impact of climate change was ignored by governments and market participants, the report predicted.

“This new research indicates that no investor is immune

from the risks posed by climate change, even in the short run,” Jake Reynolds, director, University of Cambridge Institute for Sustainability Leadership, said in a statement. “However, it is surprisingly difficult to distinguish between risks that can be addressed by an individual investor through smart hedging strategies, and ones that are systemic and require much deeper transformations in the economy to deal with. That’s what this report attempts to do.”

Two climate change paths considered: ignoring the problem and taking slight action

The report considered two probability paths: society essentially ignoring the problem and failing to take meaningful action, and then if governments move to limit the average global temperature increase to 2 degrees, a move that would require shifting to a low-carbon economy. Under certain circumstances, government action on climate change could cause sharp losses initially – particularly in aggressive portfolios – but those portfolio loses would recover by nearly ¼ five years after the low carbon economy plan was implemented.

“Even in the short term, climate risks pose a significant threat to investment portfolio performance,” the report concluded. “In the worst-case scenario, a global recession occurs during the first three quarters of the shock and the global economy never recovers, losing an estimated 16 percent of economic output by 2050.”

The general population will become more acutely aware to climate change as odd dichotomies in historic weather patterns become undeniable. The report noted that as “regulators and financial markets react in light of new information about climate change, including major events such as storms, floods and droughts,” the need to change economic incentives in the economy will make such action more probable. “This will influence financial market behaviour gradually in the first instance (led by the most informed investors) and then, potentially, in a more disorderly fashion as markets seek to shed at-risk assets.” It is that “disorderly fashion” where investor’s emotions typically drive prices into deep value levels as fear becomes the driver of market behavior over greed.

There are investor solutions to prepare for climate change, but only 50 percent of a portfolio can be protected.There are solutions for investors. “Some of the economic losses incurred by investors in this transition can be avoided or hedged through mere reallocation strategies, while others require system-level intervention in the form of policy or regulatory action.”

The report claimed that nearly 53 percent of climate change risks could be hedged through asset reallocation. “An investment manager wishing to hedge climate risks… is advised to adopt the High Fixed Income portfolio containing assets from developed markets,” the report recommended. “Even though long-term returns are low in this case, downside losses are minimized. In the event of a Two Degrees scenario, there is little opportunity to hedge downside climate risk through portfolio construction. In the event of a Two Degree scenario an Aggressive portfolio offers the best positive returns over the long term. In the event of a No Mitigation scenario, the High Fixed Income scenario offers both the best protection against downside risk and the best long-term performance”

Worst climate change investments include real estate, basic materials, construction, industrial manufacturing, energy, agriculture

The report noted that investments in real estate, basic materials, construction and industrial manufacturing would be the worst investments in developed economies. In emerging market countries the worst performing sectors would be energy / oil and gas, consumer services and agriculture. Separate analysis indicates investments to watch closely include the REIT Farmland Partners Inc. (FPI), Snap-On Inc (SNA)., British Petroleum (BP), Occidental Petroleum (OXY), Exxon Mobil (XOM), Petrobras (PBR), Potash Corp (POT), Schlumberger Ltd. (SLB) But even knowing a crisis might impact the economy doesn’t necessarily mean the right stocks can be selected.

“Investors cannot entirely shield themselves from the exposure to climate change,” the report warned, while at the same time claiming 47 percent and 49 percent of impacts due to climate change can be hedged through cross industry and portfolio construction. Climate risks “will remain an aggregate risk driver that requires system-wide action to mitigate its economy-wide effects.”

See full study here.