The increasing frequency of extreme weather events is compelling private equity investors to reassess a novel source of financial risk: the ability of assets within their portfolios to retain value in the face of climate change.

For decades, the investment models of major global funds have largely relied on historical data, operating under an assumption of generally stable climatic conditions. However, record-breaking heatwaves, floods, hurricanes, and wildfires, driven by global warming, are posing new threats to the profitability, asset valuations, and ultimately the exit returns of portfolio companies.

Chetan Chhatwal, a partner at Baringa Partners LLP, a Los Angeles-based consultancy advising over 50 private equity funds, which sold a climate scenario analysis model to BlackRock's Aladdin Climate platform, stated: "This is more about identifying the risks that could cause an investment to fail, or suddenly bring huge costs during the investment period. Any work that can prevent such situations is far from just a box-ticking exercise."

An analysis of the latest sustainability reports from 12 major global alternative asset managers reveals that mentions of "physical climate risk" and related terms have nearly doubled compared to the previous year. Firms like The Carlyle Group, General Atlantic, KKR & Co., and Partners Group showed particularly significant increases. Most institutions have now begun screening their assets for vulnerability to heat, treating it as a long-term and persistent risk source. The total value of the related private equity assets exceeds $700 billion.

In recent years, economic losses from natural disasters like hurricanes and wildfires have been on a steady rise. The combined effects of climate change, urbanization, and inflation are making the economic toll of each disaster more severe. A stress test by Allianz SE indicates that Europe will be particularly vulnerable to extreme heat over the next five years. The potential economic losses for France, Italy, Germany, and Spain, stemming from reduced fixed asset investment and lower consumption, could collectively reach $638 billion.

Among the 12 private equity firms surveyed by Bloomberg, Partners Group is one of the few that classifies heatwaves alongside hurricanes, wildfires, and floods as "acute risks." The firm noted in its latest sustainability report that heatwaves could impose additional cooling costs on portfolio companies.

Zoe Haseman, Head of Sustainability for Infrastructure at the firm, explained that these risk assessments help answer: "What assets have we actually bought, and how will that impact future planning for operational expenses, capital expenditures, and insurance costs?" By 2050, extreme heat, heavy rainfall, and drought are projected to become the most significant risks to the investment portfolio of EQT AB, with the Southeastern US, the Mediterranean region, and Southeast Asia identified as the most vulnerable areas.

According to Franziska Zimmermann, Managing Director of International Sustainability at Temasek International, advancements in artificial intelligence are enhancing data collection capabilities, aiding the firm in incorporating physical climate risk scenarios into its economic modeling. She remarked at a recent briefing in Singapore: "For example, if there is a heatwave, will consumer demand increase or decrease? How will inflation be affected? Does the consumer's ability to purchase certain products still exist?"

Its parent company, Temasek Holdings, with a current portfolio net value of S$518 billion (approximately $401 billion), is conducting stress tests for physical climate risks over the next 20 years. The current baseline climate scenario assumes a global average temperature rise of 2.4 degrees Celsius above pre-industrial levels by 2100. Temasek has also engaged with insurance companies to explore differentiated pricing for firms that implement measures to prevent disasters and mitigate extreme weather impacts.

As more industries require physical climate risk analysis, private equity funds, venture capital firms, and large asset owners are also entering this space for investment opportunities. While AI has attracted significant capital, the climate risk industry is experiencing rapid growth.

Boston Consulting Group estimates that the climate prediction and risk assessment industry, encompassing firms involved in environmental analysis, disaster modeling, and risk warnings, could double in size to approximately $13 billion by 2030.

However, disclosure regarding the impacts of weather remains in its early stages. Due to variations between climate models—including differences in data interpretation, metric selection, and averaging methods—estimates of disaster risks and potential losses often diverge significantly.

Adriel Lubarsky, founder of risk management software firm Beehive Climate, emphasized that assessment alone is insufficient to truly protect assets. "You need to know how to act on that information, and you also need to have the capital, internal resources, and decision-making support required to implement the necessary measures."