Climate change is one of the greatest threats facing our planet. And while investor focus has been directed towards addressing this challenge, we believe a key part of the solution, healthy oceans, is being neglected. Portfolio manager Kris Atkinson makes the case for why healthy oceans are critical to tackling climate change.

Key points

• Oceans play a fundamental role in regulating the planet’s climate and are essential for maintaining the overall health of the planet.
• The under-pricing of risks associated with physical climate impacts can lead to mispriced assets, misallocation of capital, and a lack of preparedness for the potential shocks that may arise.
• Given the asymmetry of debt risk and returns, bondholders are accustomed to pricing tail risks, however they are only just beginning to price the transition risks associated with climate change.

According to the United Nations, “the ocean generates 50 percent of the oxygen we need, absorbs 25 percent of all carbon dioxide emissions and captures 90 percent of the excess heat generated by these emissions. It is not just ‘the lungs of the planet’ but also its largest ‘carbon sink’ – a vital buffer against the impacts of climate change”.

The connection between ocean health and climate change as a self-reinforcing cycle is often underestimated. Climate change, driven by greenhouse gas emissions, triggers rising temperatures and altered weather patterns, which directly impact oceans. Sea-level rise, ocean warming, acidification and changing currents degrade marine ecosystems, causing coral bleaching, habitat loss and reduced biodiversity. As ocean health deteriorates, the feedback loop amplifies climate change impacts. Therefore, the oceans play a fundamental role in regulating the planet’s climate and are essential for maintaining the overall health of the planet.

The oceans play a crucial role in regulating the Earth’s temperature

As vast heat sinks, oceans absorb and store large amounts of heat from the atmosphere. The immense volume and thermal capacity of the oceans helps to stabilize global temperatures by absorbing excess heat and release it gradually over time. This regulation of temperature helps to mitigate the impact of climate fluctuations and reduces the severity of extreme weather events, providing a more stable climate system.

Oceans exert significant influences on weather patterns on a global scale. Ocean currents transport heat and moisture across different regions, influencing weather systems. Additionally, phenomena like El Niño and La Niña events in the Pacific Ocean can alter atmospheric circulation patterns, leading to shifts in rainfall patterns and temperature distributions. Changes in ocean temperatures and circulation patterns affect precipitation, wind patterns, and overall climate variability.

Failing to price in physical climate risks

The pricing of financial markets often fails to adequately account for the long-term risks associated with physical climate risks. Poor ocean health is an important aspect of climate change that has significant long-term implications for various industries, economies, and communities worldwide.

The under-pricing of risks associated with physical climate impacts can lead to mispriced assets, misallocation of capital, and a lack of preparedness for the potential shocks that may arise.

One reason for this mispricing is the complex and interconnected nature of natural capital, including ocean health and climate impacts. Measuring, understanding and quantifying the specific financial implications of, for example ocean related, risks can be challenging due to the cascading effects they can have on various sectors such as coastal real estate, fisheries, tourism, and more broadly supply chains.

In addition, the long-term nature of ocean health impacts presents a challenge in the context of more short-term focused market dynamics, where a focus may lie on the immediate financial performance rather than long-term sustainability. There may be a disconnect between the time horizons of the financial markets and the gradual, yet significant changes occurring in terms of climate and biodiversity loss, leading to a lack of urgency in incorporating these risks into pricing models.

Impact on bondholders

Nowhere is this risk more acute than fixed income. Given the asymmetry of debt risk and returns, bondholders are accustomed to pricing tail risks, however they are only just beginning to price the transition risks associated with climate change. Physical risks arising from factors such as changing ocean health, are yet to be measured and priced in systematically.

The impact of physical risks is beginning to unfold, and we expect these to grow in frequency and severity. In the medium term, acute weather events are expected to continue to increase in severity and frequency, which could lead to business disruptions across issuers held in fixed income portfolios. In long term (10+ years), it is likely we will see increases in both the prominence of chronic physical risks and the severity of acute physical risks. Physical climate risks, both acute and chronic, can cause disruptions to operations and supply chains, affect the functionality or value of physical assets, and affect access to natural resources and insurance for firms.

All of these can have detrimental impacts on an issuer’s value and lead to increased risk of loss for bondholders. Our approach to evaluating ESG risks takes into consideration the dual materiality of a company’s impact on and from its environment. Only by starting to measure and price these risks appropriately can we hope to minimize their impacts on our portfolios.

Risk Warning

• Past performance is not a reliable indicator of future returns. 
• Investors should note that the views expressed may no longer be current and may have already been acted upon. 
• The value of bonds is influenced by movements in interest rates and bond yields. If interest rates and so bond yields rise, bond prices tend to fall, and vice versa. The price of bonds with a longer lifetime until maturity is generally more sensitive to interest rate movements than those with a shorter lifetime to maturity. The risk of default is based on the issuers ability to make interest payments and to repay the loan at maturity. Default risk may therefore vary between government issuers as well as between different corporate issuers.
• Due to the greater possibility of default, an investment in a corporate bond is generally less secure than an investment in government bonds. 
• A focus on securities of companies which maintain strong environmental, social and governance (“ESG”) credentials may result in a return that at times compares unfavourably to similar products without such focus. No representation nor warranty is made with respect to the fairness, accuracy or completeness of such credentials. The status of a security’s ESG credentials can change over time. 
• Reference in this document to specific securities should not be interpreted as a recommendation to buy or sell these securities and is only included for illustration purposes.

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