Quantifying climate risk and opportunity in systematic investing

Bowie Ko, Senior RI Researcher, Responsible Investing at Man Group, shares her findings on how climate considerations can impact the success of systematic investments.

The investment case for sustainable finance faces a credibility problem. According to Morningstar, more than half of asset owners surveyed cite the impact on returns as the primary barrier to considering sustainability factors in their investment process. This scepticism isn't unfounded. ESG data has primarily been used for exclusionary screening purposes in the past – excluding controversial sectors or high-emitting companies. Consequently, ESG has become synonymous with compliance box-ticking rather than a potential factor in driving returns.

Testing the hypothesis that certain climate risks and opportunities are financially material requires rigorous, systematic analysis at scale. This is the frontier where systematic investing meets sustainable finance: quantifying climate risks and opportunities and integrating them into investment decisions through a data-driven approach.

Systematic climate investing: From ideology to evidence

Systematic investing differs fundamentally from traditional discretionary approaches. Rather than relying on subjective judgment calls, systematic strategies are governed by codified investment logic, scalable across thousands of securities.

This shift from ideology to evidence is crucial for establishing credibility in climate investing. Climate integration has traditionally resided in the discretionary space, and while systematic climate investing remains nascent by comparison, it offers transparency and empirical validation.

Two areas demonstrate how climate risks and opportunities can be quantified: real-world decarbonisation opportunities and physical climate risks.

Transition opportunities: Financing real-world decarbonisation

Research suggests that conventional “paper decarbonisation” – reducing portfolio emissions by excluding high-emitting sectors – may actually undermine real-world climate objectives. Effective decarbonisation prioritises financing emissions reductions over merely reducing financed emissions.

Identifying potential transition winners before the broader market recognises them may provide opportunities for both real-world decarbonisation outcomes and returns. Of course, successfully identifying such opportunities and achieving positive returns cannot be assured. A systematic framework using forward-looking indicators seeks to select two types of leaders: high emitters driving the transition (such as heavy manufacturers progressing towards lower-emitting operations) and climate solutions providers (such as renewable energy producers). Transition leaders within high-emitting sectors can be identified through metrics like green patent activity and expanding green revenue streams, while solutions providers can be evaluated based on the avoided emissions their products generate.

Physical climate risks: Capturing near-term mispricings and long-term resilience

While transition risk has dominated climate investment discourse, physical climate risks are materialising with significant financial impact. In 2024 alone, the United States experienced 27 climate and weather disasters costing over $1 billion each. These events cause extensive damage to physical assets and create cascading business disruptions across supply chains.

Physical climate risks present both short-term trading opportunities and long-term investment potential. In the near term, markets may react insufficiently following disaster events, creating inefficiencies. By combining climate models with geospatial data, researchers seek to identify which companies face material exposure to hurricanes or other extreme weather events, then evaluate whether market reactions accurately reflect long-term fundamental impact.

Over the longer horizon, identifying climate-resilient leaders may offer potential opportunities. Secondary perils – low-to-medium cost but high-frequency events such as hailstorms and wildfires – account for half of insured climate losses. Evaluating corporate resilience strategies against exposures to these recurring hazards reveals which companies are investing in resilient infrastructure or effectively diversifying operations. As climate impacts intensify, these investments could translate into competitive advantages and more stable earnings streams.

Conclusion

Climate investing's future lies in the systematic integration of financially material factors, not exclusionary screening. By combining alternative data, rigorous testing, and systematic frameworks, climate considerations can potentially be a source of differentiated returns.

Past performance does not guarantee future results, and there can be no assurance that any investment strategy will be successful.

Discover climate risk management with senior leaders at RiskMinds International. Save the date – 16-17 November 2026, London!