Climate risk is coming for your portfolio

Stocks have shrugged off oil shocks, AI bubble fears, and a slowing economy. But investors may be overlooking another oncoming challenge: climate change.

“Even sophisticated investors and companies are still figuring out how to integrate physical climate risk into broader risk frameworks and profiling,” explained Dr. Jeremy Porter, the chief economist at First Street, a climate-risk data and analytics startup that works with clients including Blackstone and Norges Bank.

Physical climate risks are just that: the direct damage caused by climate-related events like floods, wildfires, hurricanes, heat waves, droughts, and severe storms, all of which have become more frequent over the last few years.

We spoke to Dr. Porter about First Street’s research report, which details how the Dow 30 is facing billions of dollars in climate losses, why investors are underestimating climate exposure, and how investors measure companies’ exposure to climate risks.

Our conversation has been edited for length and clarity.

You describe climate risk as “the new cost of doing business.” What has changed that makes this moment different from five, or even 10 years ago?

When people start to think about much they should take physical climate risk into account, really what they’re focused on is: How much does it impact revenue? How much does it impact OpEx, capex, the core financials?

When we looked back through 10-K filings, we found that mentions of physical climate risk as a concern for revenue disruptions have doubled since 2000. It went from about 32% of 10-Ks mentioning it in 2000 to about 65% in 2024.

We’ve also seen an increase in actual warning reports tied to climate risk. These are reports companies issue after events, warning about revenue disruptions. Between 2000 and 2005, there was a slight increase. From 2005 to 2017, it felt like there was a new but stable baseline of climate risk. But we’ve seen a tremendous uptick since 2017, along with more severe, more frequent climate disasters, which are materially causing risk, which are showing up in those 8-K and 10-K trends.

Was there a specific data point or finding in the report that surprised you?

I was surprised at the amount of exposure and the amount of negative and below-expectation revenue returns that we would see even one year post-climate disaster.

We were ultimately seeing that there are persistent losses that companies aren’t able to just correct for after 30 or 60 days, and ultimately it’s impacting the revenue long term. Over half of companies that were impacted, I saw either below average revenues or negative revenues.

For investors trying to distinguish between companies likely to recover quickly from natural disasters versus companies facing more structural risks, how can they tell the difference?

It comes down to understanding the operational business model. For example, REITs that own retail spaces, apartment buildings, or shopping centers rely on leases and rents that may not immediately be disrupted by climate events.

But if climate risk affects a manufacturing or distribution facility, revenue can stop immediately until operations are restored. Investors doing due diligence generally understand those operational differences.

You say in the report that markets tend to react quickly to these big, high-profile climate events. Do you feel like investors tend to overreact in the short term, or are they still underreacting to the long term risk?

In the short term, we almost always see post-profit warnings and 8-K announcements, and we will see an immediate dip in valuation or abnormal returns on a company’s equity. There are valuation impacts in the short term, but something like an REIT actually responds really quickly. They tend to be real assets that are located in highly desirable economic markets.

There are some other asset types and other sectors that don’t respond quite as quickly from an investor perspective, post-event. Some of that has to do with utilities and liability issues, post-wildfire events and things like that.

How does your methodology differ from more traditional ESG frameworks?

A lot of frameworks focus on two verticals: physical climate risk and transition risk. ESG has historically focused more on transition risk—carbon emissions, carbon pathways, and mitigation. Transition risk is important, especially when cities or states impose new carbon regulations, there can be fines and adaptation that has to take place and is really expensive.

But more recently, businesses are focused on physical climate risk and their exposure to it and the impact to their bottom line.

Transition risk can sometimes feel more theoretical or idealistic because it’s about reducing carbon emissions. But the real world situation for a lot of companies is that they are being hit by physical climate-risk hazards, like floods, wildfires, and wind storms.

But what we have seen is that physical climate risk is being presented now as a value proposition for companies: Companies that are ahead of the game, that are taking this data into account, that are treating it as material risk and integrating it into their decision-making processes, are ultimately seeing alpha attached to it. They’re seeing the ability to increase cash flow and reduce revenue disruptions, and that’s then making its way into valuations and some of the decisions investors are making. So overall, physical climate risk has become a business opportunity.

Do you feel like markets right now are still underestimating climate risk, or is it starting to be priced incorrectly?

I think it’s being underestimated. I think even the most savvy investors and the most savvy companies that are taking this into account are still trying to figure out how to integrate it into their larger risk framework and their larger risk profiling.

I think that it’s something that people are recognizing is a material issue. But I don’t think that we’ve gotten to a place yet where there’s a good understanding of how to assess physical climate risk and its impact on revenue disruptions and valuations.—LB