How Two Asset Managers Think About Climate Adaptation Investing

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Hot new investment trend or climate finance’s problem child? It’s a question investment managers are grappling with when it comes to climate adaptation. 

Seen from one angle, adaptation looks like a non-starter for private investors. Finding assets that match the category is hard, many conventional projects lack clear revenue streams, and most are located in the developing world — posing credit, geopolitical, and reputational risks.

However, this is a myopic perspective. In reality, everyone, everywhere needs to adapt. While the urgency and scale of adaptation will differ by region and sector, all entities will have to climate-proof their operations one way or another. 

It follows that demand for climate adaptation products, services, and data will explode in the coming years. Investors that get a head start on this trend could make bank. In fact, the Global Commission on Adaptation estimated in 2019 that investing US$1.8tn in climate adaptation measures by 2030 could yield US$7.1tn in net benefits. 

Some investment managers are cottoning on to the opportunity here. Climate Proof caught up with two such firms – WHEB Asset Management and Impax Asset Management – to better understand how they approach this emerging investment theme.

Making the Case

WHEB is a UK-based boutique asset manager, overseeing £1.2bn (US$1.5bn) of client assets. It runs a global mid-cap equity strategy that invests in companies providing solutions to sustainability challenges, organized across nine themes: Cleaner Energy, Education, Environmental Services, Health, Resource Efficiency, Safety, Sustainable Transport, Water Management, and Well-being.

In January, WHEB announced it had established climate adaptation as a sub-theme. The decision both acknowledged the importance of this topic to WHEB’s investing approach and allowed for an expansion of the asset manager’s investable universe.

“It’s clear from the trajectory we’re on that the world is going to need an awful lot of adaptation, and the less successful we are at mitigation the more we’ll need to spend on both mitigation and adaptation. We’ve pulled it out as a theme because the science is so clear,” says Seb Beloe, Head of Research at WHEB.

Impax Asset Management is another UK manager, with £40.4bn (US$51bn) in assets under management. Unlike WHEB, it invests across asset classes, focusing on issuers it believes are in pole position to benefit from the transition to a sustainable economy. The firm’s climate strategy invests in a portfolio of 50 to 70 listed companies “that have demonstrable exposure to products and services that enable mitigation of climate change or adaptation to its consequences.” In addition, Impax has contributed to the Institutional Investors Group on Climate Change’s effort to create a climate resilience investment framework. This describes how investors can encourage companies to develop more effective adaptation plans.

However, even a firm as climate-forward as Impax is finding adaptation a tricky theme to define. “We’re really in the early stages of understanding the adaptation ecosystem,” says Julie Gorte, Senior Vice President for Sustainable Investing at Impax. “There’s no generally accepted taxonomy. But we’ve been engaging with companies in the S&P 500 for five years now on physical risk and adaptation. And we’ve kind of got a house view on what companies should do to adapt,” she adds.

This “house view” is arrived at after exploring a company’s climate-related physical risk exposure to a number of factors, including business model, asset location, and value chain. To date, this approach has surfaced vanishingly few US companies with strong adaptation capabilities.

“I think I have more fingers than there are companies that really do a good job of assessing their value-at-risk,” says Gorte, though she admits firms are “getting better” as their awareness of physical risks has grown.

Picking Investments

At WHEB, adaptation investments are sorted into two rough groupings: “adaptation intelligence,” covering issuers working on things like weather monitoring systems, remote sensing equipment, and environmental assessments, and “adaptation products and services”, encompassing disaster recovery, water management and storage, weatherization, climate-resilient agriculture, and more.

“For us to be invested, companies need to be getting at least 50% of their revenues from activities we consider to be having a positive impact on adaptation, that’s the first step for them getting into our methodology,” says Beloe. 

At present, a fair number of companies in this investable universe are engineering or consulting firms. Beloe calls them the “brains” of the adaptation economy. It includes the Netherlands-based design, engineering and management consulting company Arcadis, which is currently working with New York City to improve the climate resiliency of lower Manhattan. Its stock has been on a tear of late, up almost 230% over the last five years.

Arcadis Five-Year Stock Price

Beloe’s hunch is that these “brains” will foster the conditions for more adaptation products and services companies to thrive in time – the “brawn”, if you will.

For now, picking companies producing genuine adaptation solutions is challenging. This being a nascent space, there’s little consensus on what should count as a true adaptation company – hence the flurry of activity over taxonomies. Gorte sums the problem up neatly:

“We know what the solutions providers are for transition risks – renewables companies, water companies, etc. When it comes to the adaptation side, we can name a few categories, but it’s incomplete. You can sort of look at the number of physical risks both chronic and acute, and say: ‘Are you producing something that enables others to be less vulnerable to drought?’” she says.

“We also have to be really careful about the idea that just because a company calls something an adaptation solution that doesn’t mean it’s going to help,” she adds. This is a reference to “maladaptation” –  actions intended to help protect against climate shocks that actually create more risk and vulnerability. 

Reaping the Rewards

Those companies that do make the grade offer investors multiple benefits. For one, adaptation investments could outperform in a world where the Paris Climate Agreement’s temperature thresholds are breached. 

This makes them a useful risk offset for institutions’ climate mitigation bets. “It’s almost a hedge,” says Beloe. “As an asset manager we’re all in on sustainability, and our base case is a 1.5°C world. If we have to give up on 1.5°C the question is: what can we do about it? It makes sense in this context to see adaptation as a way of coping with the implications.”

Adaptation investments also have the potential to generate alpha against a backdrop of increasing extreme weather events and other climate physical risks. “There is money in it. It’s clear that if you can do a better job of, for example, draining excess water in cities, it’s clear that that has value in the municipal context,” says Gorte. She adds that broader appreciation of adaptation’s capacity to reduce and mitigate climate losses will lead to increased institutional flows.

Beloe says institutional investors are already warming to the theme, particularly those that already “get” climate. He expects that as the messaging around adaptation sharpens, many more asset owners will get on board.

“If you get the science, why wouldn’t you think about adaptation – it’s a compelling trend that will be with us for decades, so it should be of interest to anyone who wants to make money,” he says.