Global Weekly Commentary: Real resilience in sustainability
The tectonic shift toward sustainability is gaining pace. We highlight an underappreciated climate-related risk to portfolios: water stress.
Negotiations have kicked off over the size and make-up of a new U.S. fiscal package as key benefits are set to expire and states face budget shortfalls.
U.S. consumer confidence
U.S. consumer confidence is in focus this week as the fiscal cliff nears and the pandemic's spread in Sunbelt states is starting to affect economic activity.
We have pointed to a tectonic shift toward sustainability, and how the global pandemic has accelerated this process. This highlights the need for real resilience in portfolios to guard against risks ranging from vulnerable global supply chains to the intensifying effects of climate change. We see room for sustainable assets to outperform in the long transition to a low-carbon world.
Chart of the week
Projected water stress around the world by risk zone, 2030
Source: BlackRock Investment Institute and BlackRock Sustainable Investing, with data from the World Resource Institute, June 2020. Notes: WRI defines water stress as the ratio of total water withdrawals to available renewable surface and groundwater supplies. Higher water stress levels indicate more competition among water users. Water withdrawals include those from irrigation, livestock, industrial use, and domestic sectors. Available supplies capture natural runoff as well as the impact of upstream water use and dam operations on downstream water availability. Water stress assesses on WRI's five point scale, ranging from "low" to "extremely high" (1 to 5) for illustrative purposes only. Forward-looking estimates may not come to pass.
Water stress – when demand for water exceeds supply – is an underappreciated risk that cuts across regions, asset classes and sectors. It is a component of growing climate-related risks such as hurricanes, wildfires and flooding, and threatens public health, production facilities and global supply chains. Large cities will need to strengthen their water infrastructure. Within a decade, much of the world will lie in regions of high water stress, projections by the World Resources Institute show. Northern Africa is one high-risk zone, as seen by the red tones in the chart above. The risks also have geopolitical dimensions, as highlighted by a recent spat over a large hydroelectric project in Ethiopia that neighbors Egypt and Sudan fear could reduce water availability. Combining climate modeling with the geolocation of physical assets can help investors get a better handle on the risks to companies and their human capital.
Companies in water-stressed locations may need to spend more to source water, to raise water efficiency and to meet more stringent environmental regulations. For details, see our new publication Troubled waters. Regulators are zeroing in on water-related risks: A recent European Central Bank report included water stress among the physical climate risks it may require financial institutions to manage and disclose.
The causes of water stress are varied. Population growth and urbanization increase demand for water and strain resources. At the same time, climate change is shifting the distribution of water supply by disrupting precipitation patterns. The agricultural, textile, energy, industrials, chemicals, pharmaceutical and mining industries account for around 70% of freshwater usage globally, according to the Carbon Disclosure Project’s 2018 Global water report. The risks from water stress are most acute in water-intensive industries. In the agricultural sector, reduced water availability for irrigation can lower crop yields. In electric utilities, water is critical for cooling thermal power plants. In real estate, climate-related risks such as water stress could accelerate a tenant preference for “green” buildings. And the creditworthiness of some countries, states and municipalities facing water shortages could come under threat due to rising costs to fortify water resources.
We believe increased asset flows into sustainable investing strategies in 2020 are part of a tectonic shift that could last decades. A societal shift toward sustainability and growing awareness of related risks are behind these flows. Climate-related events such as extreme weather are already causing real financial damage, as we detailed in Getting physical in April 2019. We believe many of the risks are not yet priced in by financial markets. A strategic tilt toward assets that score highly on sustainability may mitigate the risks, helping provide real resilience in portfolios.
Bottom line: Companies resilient to water stress and other climate-related risks may fetch a premium in the transition to a low-carbon economy. Better understanding and quantifying the risks can help investors mitigate exposures and potentially exploit any mispricing. Investors today have more options than ever before to integrate sustainability into portfolios. This includes thematic investing that targets specific sustainability trends – and new benchmarks that offer broad market exposures while providing a tilt to sustainability.
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