Quick Thoughts: The Connection Between Climate Change and Geopolitics

by Stephen H. Dover, CFA, Franklin Templeton Investments

Successful international investing includes measuring financial risks and rewards caused by events in an affected country. Stephen Dover, Head of Franklin Templeton Investment Institute, discusses how macroeconomic and political research complemented by environmental, social and governance (ESG) research provides investors additional prisms to view a country’s financials, impacts on climate change, and geopolitical risk.

International investments offer portfolio diversification potentially from exposure to countries outside the US. Successful investing includes measuring financial risks and rewards caused by events in an affected country. Today, macroeconomic and political research, complemented by environmental, social and governance (ESG) research provide investors additional prisms to view a country’s traditional financials and impacts on climate change.

• Climate change is a systemic risk that affects investments and cannot be hedged. The ripple effects of climate change events spread beyond cities, countries, and into neighbouring countries with geographic, climate, or economic linkages.
• Most investors and lenders react by incorporating relevant signals in their risk assessment models. This may not be enough, as climate change and geopolitics are often interdependent.
• Climate change acts as a powerful force multiplier of geopolitical risk. Accelerated by population growth and declining water resources, climate change can drive rapid and radical structural changes in affected countries’ economies and demographics.
• Specifically, water rights, access, management, climate change effects, and other water risks are drivers of geopolitical conflicts in areas where river basins lie across national borders. There is an increasing unreliability of fresh water supplies where many risks and factors coalesce, amplifying increasing water risk.
• Two of the three most exposed river basins in the world are in India—the Indus River and the Ganges-Brahmaputra River. They are experiencing population growth, disrupted weather patterns, and increasing pressure on water resources, threatening the sustainability of agricultural yields and potential social unrest. These factors combine to drive existing geopolitical tensions with neighbouring countries higher.
• The Danube River crosses nine European Union (EU) member countries and five non-members. Tensions exist between EU members and non-members on a variety of issues, including economic aid and potential accession to EU membership.

Read more on this topic in Franklin Templeton Investment Institute’s The Nexus Between Climate Change & Geopolitics. We examine two relatively underappreciated waves—geopolitics and climate change—to demonstrate the interdependencies between them and identify flashpoints that should be monitored.

What Are the Risks?

All investments involve risks, including the possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested.

Special risks are associated with investing in foreign securities, including risks associated with political and economic developments, trading practices, availability of information, limited markets and currency exchange rate fluctuations and policies; investments in emerging markets involve heightened risks related to the same factors.

Actively managed strategies could experience losses if the investment manager’s judgment about markets, interest rates or the attractiveness, relative values, liquidity or potential appreciation of particular investments made for a portfolio, proves to be incorrect. There can be no guarantee that an investment manager’s investment techniques or decisions will produce the desired results.

Diversification does not guarantee profit or protect against risk of loss.

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