Physical risk: quarter of equity holdings in asset owner portfolios face ‘severe hazards’

“The system is quite an unusual one”, said Jamaican prime minister Dr. Andrew Holness, a few days before Hurricane Melissa made landfall. The category five storm, that has caused damages in the range of $6bn - $7bn, is yet another reminder of the toll of acute weather events.

Such events are now more frequent and severe than they were before. Crucially, they have direct and immediate investment implications.

New research from MSCI and Swiss Re shows 25% of listed equity portfolio value is currently facing severe hazards. The study is based on data from 18 asset owners with a collective $2tn in listed equity exposure and $4tn under management.

Regional tilt

Exposure to acute weather is closely linked with a portfolio’s geographical footprint. That footprint is a core theme of asset allocation changes in asset owner portfolios both past and present. The UK’s Mansion House Accord, for instance, aims to steer the country’s pension capital inward. Regulatory efforts to attract asset owner capital to home turf are increasingly common.

As regional tilts become more evident in portfolios, they have vital implications for where, when and to what extent physical risk vulnerability show up.

“Regional concentration alone doesn’t determine vulnerability — location does. What matters is where the underlying assets are physically located, not where the companies are headquartered”, says Xinxin Wang, an executive director at MSCI Research.

Wang raises a crucial clarification – regional tilts do not necessarily imply regional concentration of hazard exposure. This has to do with the multinational footprint of companies in listed equity portfolio, even when they might be headquartered in a given country.

The report cites the case of Heidelberg Materials AG, a German materials company with 92% of its output generated outside its home country.

While regional tilts don’t necessarily concentrate physical risk exposure, it almost certainly shapes it.

“For example, we found that portfolios with a stronger allocation to emerging markets are more exposed to heat waves and water scarcity. Whereas portfolios tilted toward developed markets are more exposed to wet/cold hazards, including heavy snowfall, hail and extreme cold”, Wang explains.

Financially material

The researchers constructed a ‘combined asset owner portfolio’ to map hazard exposure. They find that 25% of the portfolio weight (55% of companies) faces at least one hazard with intensity value 9/10 or higher.

“Physical risk is financially material for investors now. Integrating asset-level geospatial intelligence allows investors to pinpoint where hazards concentrate, treat siting as a financial variable, and identify companies whose operations or supply chains drive vulnerability”, says Wang.

For investors, how and when hazards impact returns is a key piece of the financial materiality puzzle. Evidence on that front is growing. In September, Wang and her co-authors published research linking hurricanes with underperformance.

The implication being that physical risk is no more an expected losses paradigm - losses are here and now.

Cushioning

To address the risk, asset owners might look to a combination of two solutions – insurance and adaptation investments. Researchers find strong evidence to suggest an either/or approach could be misplaced.

The report suggests 57% of catastrophe losses in 2024 were uninsured. The insurance protection gap, in the context of physical risk is hugely consequential.

“The implication for asset owners is to treat insurance as partial cushioning rather than a complete solution”, warns Wang.

“Resilience — through site hardening, backup systems, diversified suppliers, or improved water and heat management — shrinks the loss before it occurs”, she adds.

As investors and regulators gather in Brazil for PRI in Person ahead of COP 30, physical risk is high on the agenda. ‘The heat is rising’ reads one of the plenary titles. In São Paulo and beyond, the fact that over a quarter of listed equity portfolio value is located in high hazard zones is hard to ignore and crucial to address.