As the world moves to mitigate the effects of climate change by transitioning to a low-carbon economy, capital markets will increasingly feel the effects, and fixed income investors should be prepared to manage the attendant risks and opportunities in client portfolios. In our view, it is especially important with longer-term, low-turnover investment strategies for investors to understand how climate-related transition risks affect issuer sustainability and credit quality, as well as bond prices and valuations.
We believe companies that are better equipped to navigate the evolving transition-risk environment may be attractive long-term investments, so assessing these risks has become integral to our credit research and investment process. In low-turnover approaches in particular, investors need to ask themselves if the issuers they invest in will be relative outperformers in 10 years' time. Are their business models fit for purpose in a low-carbon economy, and if not, are they willing and able to pivot? Here, we share our approach to transition-risk analysis and how we think about investment opportunities in carbon-intensive sectors. Our aim is to identify material transition risks, quantify which sectors will be most affected and mitigate portfolio-level risk via our issuer- and issue-selection process.
Why transition risks matter for credit investors
While the physical risks of climate change — heat, drought, hurricanes and floods, among others — can directly impact companies' tangible capital assets, operations and labor forces, transition risks — the costs associated with transitioning to a low-carbon economy — may require certain industries to consider even more sweeping changes to their operations and potentially business models. Regulation, technological disruption, litigation and changing consumer behaviour can affect a company's economic stability, competitiveness, reputation and credit quality. We believe these risks are underappreciated and will continue to evolve, with lasting impacts as the investment industry reprices securities based on the lower terminal values of legacy assets and capital expenditures required for strategic transformation.
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