One of the most indelible one-liners of my early teenage years came from the young Canadian music icon Avril Lavigne: “Why’d you have to go and make things so complicated?” As a teen navigating the thrills and thralls of growing up, her words resonated.
I had to think of Avril Lavigne at RI Europe this month and I am sure I was not the only one. Exploring physical risks in the interactive “Let’s get Physical” workshop session, we were reminded that physical risks are complicated.
But perhaps just a little bit, we make it so too? Overwhelmed by the apparent complexity of measuring, managing and ultimately mitigating physical risks, we are maybe missing the forest for the trees.
For the moment, it is obvious that the systems to manage systemic physical risks are still lacking in the investment landscape.
Incidentally, I think this is less and less an issue of data. Geolocational asset data mapped to physical risk maps has become the price of admission for data providers wanting to play in the physical risk space.
In fact, I actually don’t think it is that complicated. When it comes to physical risks, there are effectively four personas in the investment world.
The first way to approach physical risks is through a character I’ll call “Macro Mark”. Mark is tired of living like a blind man. He wants to know. But he sees physical risk as a systemic issue. Why worry about the flooding of an asset when long-term growth rates are on the line?
For Macro Mark, physical risk are important enough that the primary way they should be addressed is at asset allocation level – which markets, which asset classes?
The missing ingredient for Macro Mark: the social impacts of climate change. Without understanding the second order effects on migration and civil conflict, the analysis will inevitably be incomplete. Once that puzzle is in place, Mark can make it as a wise man.
The second profile is Gina Geolocational. She thinks the macro analysis is too uncertain to be actionable. The research just isn’t mature enough. But what we do know is the location of assets (exposure). We know the expected evolution of hazards. And while vulnerability is a question mark, exposure + hazards already provides a strong foundation for stock picking and bond portfolio allocation.
For Gina, the key barrier is translation. How do I convert flood map exposure scores into financial outcomes?
Then there is Amy Adaptation. She has a fundamentally different question. Keen to not let a crisis go to waste, Amy understands that physical risks will require a different built environment. And that companies that can deliver that different environment will succeed. As will those companies whose products and services will be needed in a crisis.
What will happen to construction materials when depreciation rates go up? What other materials will become important? Which service infrastructure will help adapt and overcome physical risk events? And what companies will be resilient to the economic volatility these risks will engender?
For Amy, the geolocation of assets is irrelevant, as are the macro GDP impacts. Physical risks are happening, defining them precisely is Fool’s Gold, as long as we know they are coming, we can build an investment case of who will benefit (however cynical that thinking may appear).
Finally, there is Not Now Nelly, who clearly doesn’t seem to notice that it is getting hot in herre (if Responsible Investor readers will allow the musical crossover). He tries to be cool, convinced that in the context of Ukraine, Middle East, and all else, it simply isn’t the time to think about physical risks.
I obviously disagree with Not Now Nelly. But there is a point to his thesis: The ‘half-half’ approach to physical risks that some investors are pursuing at the moment is the worst of both worlds.
Spending resources on a topic without translating associated insights into investment implications is inefficient.
Until data gets actioned, whether we like it or not, we are somehow all Not Now Nellys.
Of course, if we are not careful, being a Not Now Nelly, permanently saying “See you later boy!” risks eventually being too late.
This is where our other three personas can hopefully help, crystallizing the choice as to how to approach this big bad physical risk spectre haunting investors, how to avoid still being a Not Now Nelly in the future.
To be clear, I am not saying you have to choose one character always and forever. But if you try to be everyone at once, it simply becomes too complicated.
Simpler framing is possible: when it comes to physical risks, the foundation in terms of data and tools is largely there. We just have to decide whether and how to use them, to remind ourselves of what or who we really are: Mark, Gina, Amy or indeed Nelly?
Jakob Thomä is co-founder of Theia Finance Labs (formerly Two Degrees Investing Initiative), research director at Inevitable Policy Response and professor in practice at University of London SOAS.
