What war can teach investors about climate risks

Published on: 30 January 2023

Suppose war is coming, or a hurricane is on the way. What should you do as an investor? Get out of risky stocks and flee into safe government bonds? Sell your real estate investments before the bombs fall on the apartment buildings, or the raging winds blow away the roofs? I’ll get to the answer in a minute.


Why am I bringing up this kind of misery? It is related to climate change. You have to deal with that as an investor. Climate change - and policies to mitigate it - is a very decisive factor in the economic environment. Climate risk should therefore play a role in the most important investment decision you make: how do I diversify my portfolio across categories like bonds, stocks, real estate and commodities? The only problem is: climate change is new. Dinosaurs have experienced the current high concentration of carbon dioxide in the atmosphere; mankind hasn’t yet. The rapid increase in greenhouse gases is also unique.


So as investors, we have no guidance. There is no history of neat correlations between, say, temperature increases and the returns of various investments. And just try to model how a warming earth affects relations between countries, or migration flows and diseases.


What we do know is that climate change comes with risks. These can be physical, such as floods, droughts and crop failures. A disaster for citizens, but also for investments. In addition, you have transition risks. That term captures losses related to new technology or a change in rules, for example. For example, a ban on your product would cause your factory to lose its value.


Back to wars and disasters. These offer clues, because climate change involves similar risks, because physical destruction occurs here as well. And wars and disasters also cause transition risks through a change in rules or policy. For example, after Fukushima, nuclear energy fell out of favor in Japan and Germany, but since the invasion of Ukraine, it has become negotiable again.


Of course, no one is arguing that wars and natural disasters are the perfect analogy for climate risks. But where modeling is not an option, it can still tell us something about the impact on relative returns. Of course, investors are ultimately interested in absolute returns. But for the distribution across your asset classes, you really want to know which categories do relatively well under certain circumstances, as with the risks created by climate change and policies.


And where do you end up? We’ve figured that out at APG*. During disasters, equities and real estate turn out to perform much better than government bonds. Even during wars, it paid off to have investments with a higher risk profile such as equities, real estate and commodities in the portfolio. It is counterintuitive that especially in risky times risky investments do well, whereas government bonds are traditionally seen as a safe haven.


What is behind that? When small shocks occur, bonds offer security, but when really big problems arise, governments still end up bearing the risks. So, it remains to be seen whether government bonds really are an ideal shelter when the weather gets seriously bad.



Charles Kalshoven is a macroeconomist at APG


* This column provides a brief insight into recent APG research. For the enthusiast, see the article in the VBA-journaal