Over the past year, sustainable investors have increasingly shifted their focus from carbon reduction to climate adaptation. The shift points to a pragmatic realisation that the world is already closing in on 1.5C of temperature increase. If climate policy remains gridlocked, then physical risks accelerate while mitigation stalls – making adaptation even more urgent and valuable.
But it also represents a shorter-term, knee-jerk reaction to current political circumstances and the dismantlement of the renewable energy subsidies and incentives found in policies like the Biden-era Inflation Reduction Act. It’s a tacit admission of – and perhaps even a partial capitulation to – the idea that if policymakers won’t agree on a means to limit carbon emissions, sustainable investors are going to retreat into a resilience mindset.
The narrative around climate adaptation investment has primarily focused on steering capital toward – or financing – adaptation solutions. Policy‑driven initiatives have aimed to mobilise and crowd‑in private finance. For instance, COP30 called for $1.3 trillion in annual adaptation funding, including $1 trillion from the private sector.
Investor‑led strategies, in turn, have generally treated adaptation as a theme. While private capital has concentrated on areas like infrastructure, public‑market investors have been investing in adaptation solutions – think of companies that produce air conditioners or back-up generators for a warming world facing increasing blackouts.
While this is certainly useful, it’s an incomplete approach and not a narrative that most investors who are bound by a return objective and an underlying investment mandate can follow. If we ignore this, then we potentially perpetuate the same issues that dogged the Glasgow Financial Alliance for Net Zero (GFANZ) climate finance commitment, which assumed that investors exist in the abstract to fund climate action when, in reality, they have a fiduciary duty to prioritise financial returns.
A more useful narrative for most investors, therefore, is one which acknowledges that their primary role is to price a firm’s resilience to climate risk.
But there’s a strong case to be made that investors, especially those in public markets, aren’t doing enough to price climate adaptation risk into existing portfolios or even understand the relationship between asset pricing and a firm’s resilience to different, individual underlying physical risks – not to mention the wider link between macro-systemic risk and climate impacts.
One of the main problems is that the debate remains stuck on long-dated scenario analysis. Investors face pressure to stress test investment portfolios on 25 year-plus timeframes.
The exercise of stress testing portfolios is important and necessary, but it has crowded out discussion about more immediate physical risk considerations. In other words, the debate around climate impact often leads to moot discussions about discount rate assumptions, data quality, and how to model earth system effects like tipping points, non-linear feedback loops, or even small-scale atmospheric processes like cloud formation and turbulence.
Insurance markets, on the other hand, already understand the immediacy of the problem given they reprice climate risk on an annual basis – not in 2050.
That discipline explains why many insurers have fled Florida and California property insurance markets while reinsurance rates have spiked. Insurers are increasingly in the position of having to simultaneously respond to insurance claims, react to existing earth observational data and improve their longer-term climate risk modelling.
Investors who develop competencies in physical risk assessment are better positioned to capture mispricings that consensus approaches miss. Physical climate impacts are already flowing through income statements in the form of supply chain disruptions, production shutdowns, higher insurance premiums and commodity price volatility.
While these effects are often unevenly distributed, they are recurrent and, crucially, observable. That makes climate adaptation both a present-day earnings issue and a distant capital-allocation problem, not to mention the fact that ignoring observable operational risks – regardless of their cause – is itself a fiduciary failure.
Yet public markets continue to treat them as background noise rather than as signals to be priced. As a result, climate adaptation represents a blind spot for public markets investors. The opportunity extends well beyond financing seawall defences or buying the next basket of adaptation solutions to identifying how markets systematically underprice physical risk and where a firm’s resilience to physical risk could earn it an equity risk premium.
In that respect, this isn’t a call for a new regime of climate investing. Rather, it’s the recognition that firms which are more resilient to physical risks will increasingly carry a risk premium and those that are more vulnerable a discount. Investors will only realise this future risk premium by investing in the most resilient companies, not through capital flight away from climate risk regions, themselves.
A major reason this repricing has been so slow is the investment in specific competencies and capabilities: expertise in natural sciences and quantitative research, data and tech resources that can leverage vast government and private sector datasets, and a willingness to invest in a research-driven culture.
Investors often point to the lack of information about the exposure of firms to physical risk. But climate scientists already receive terabytes a day of data collected by NASA alone, the majority of which goes underused in climate modelling, not to mention our understanding of financial exposure relative to physical climate risk.
Nonetheless, there’s growing empirical evidence demonstrating that firms which are more effective at managing physical risks – operational disruptions from water stress, extreme precipitation, heat exposure, and other chronic and acute perils – outperform, particularly during periods of climatic stress. Man’s RI research team has written about the existence of a risk premium for companies that are more water efficient in water-intensive industries, as well as the impact of extreme heat on US equity market volatility. But that risk premium remains poorly understood, inconsistently priced, and under researched more broadly.
The irony is that while investors debate optimal climate scenarios decades out, they may already hold mispriced assets. Physical climate risk isn’t waiting for better models or greater policy clarity. It’s already flowing through earnings and balance sheets as margin compression, and asset write-downs that are too often dismissed as one-off events.
Indeed, academics have found that investors underestimate physical risk-related losses by as much as 70 percent, suggesting that valuations hide a material blind spot.
As insurers have shown, repricing climate risk is a matter of survival over ideology. Markets that fail to do the same risk misallocating capital and leaving returns on the table. The question is whether public markets will continue to treat recurring operational disruptions as idiosyncratic noise or recognise them as systematic and, ultimately, priceable.
Jason Mitchell is CIO for Responsible Investment at Man Group
