How private equity firms can strategically manage climate risks
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August 18, 2023
min read

How private equity firms can strategically manage climate risks

using a SAA approach, PE funds can manage and integrate climate risk better.

Navigating climate risk particularly for private assets has been a challenge in the investment sector. This is due to data limitations in adequately capturing factors related to climate change. However, with new advances in technology there is hope that models like the Climate Value-at-Risk (Climate VaR) 1 that has been successful in the public sector can be useful for private investments.

Incorporating Climate Into Strategic Asset Allocation

The Strategic Asset Allocation (SAA) method used in managing investment portfolios can be adapted to take climate risks into account. This can be achieved either by reducing expected returns based on climate costs after SAA (ex-post), or by incorporating precise climate costs directly into the SAA optimization process (ex-ante). Private equity is, however, faced with added data limitations in quantifying climate impacts when compared to public equities 4.

Estimating Climate Factors for Private Investments

Public market climate costs can be adjusted to serve as helpful starting points in overcoming climate data limitations in private markets. To get a more accurate forecast, adjustments must be made for structural differences between public and private markets. Key adjustments include sector composition, leverage, cost of capital and control.

Incorporating Climate Into Private Market Analysis

The methodologies for estimating and taking into account climate costs for private markets provide starting points for further analysis of the role they play in portfolio management. With the growth of private investments 12, it becomes increasingly important to evaluate how climate risks might put a dampener on returns to ensure the holistic incorporation of these factors into SAA.

15Rock's Athena Platform: Enabling Value Creation for PE Funds

Athena, 15Rock's innovative platform incorporates AI and machine learning to accurately price and manage climate risks. The platform also provides insights which when utilized proactively can form strategic growth pathways that are climate-resilient. Business can expect more investment with increased transparency in climate risk reporting. They also get the added advantage of performance improvements by integrating climate risk into their portfolio companies.

Climate Risk Management Solutions Emerge

New platforms like Athena are leveraging AI to provide real-time insights on climate risks, thereby addressing data limitations in private markets. Private investments also stand to gain from integrating climate risks, which can lead to improved performance and resilience over the long term.

The Need for Climate Risk Integration

The integration of climate risks into private market investments is becoming increasingly important with the growing concern about climate change. As data quality improves, these risks can be identified and incorporated into private market allocations. Advanced platforms enable businesses and investors to make climate-friendly decisions thereby paving the way to a more sustainable future 25.