CONTRIBUTORS
David Zahn, CFA, FRM
Head of European Fixed Income,
Franklin Templeton Fixed Income
Kasper Hanus, Ph.D
Senior Sustainability Manager,
Franklin Templeton Fixed Income
Joanna Urbaniak
Sustainability Analyst,
Franklin Templeton Fixed Income
In August 2023, Slovenia suffered some of the worst flooding in its history. Approximately 85% of its municipalities1 endured severe floods and landslides, exacerbated by the country’s mountainous topography. According to the government's estimates, the direct cost of the damages was as high as €9.9 billion,2 or 16% of the country’s 2023 gross domestic product (GDP).3 That’s the equivalent of buying five iPhone 15s for every Slovenian resident (though it is important to note the sovereign does not shoulder this cost alone).
Such extreme weather events will become increasingly frequent and are a sad consequence of climate change.4 It is clear that these events both wreak havoc and come with a hefty price tag. Consequently, we as investors wanted to know how Slovenia was coping with the repercussions of the recent floods, and how it was preparing for more to come.
As part of the Franklin Templeton Fixed Income team engagement strategy, we meet regularly with issuers to discuss the matters we deem pertinent to the successful attainment of our funds’ investment goals. We therefore arranged to meet with Slovenian government representatives from multiple ministries and governmental agencies. We were impressed by their multi-pronged approach to flood risk mitigation, one that comprises advanced warning systems, public education initiatives, protection measures for existing infrastructure, special permits for new construction and bilateral cooperation.
Slovenia has a modern early-warning system based on extensive monitoring (of meteorological, hydrological and oceanographic conditions in the country and surrounding areas) and advanced forecasting models. This system is responsible for triggering the national early-warning notification. Collaboration is the key to success here, with cooperation across multiple ministries as well as with firefighters, divers, civil protection units and volunteers across the country.
Training is another pillar of Slovenia’s flood preparedness efforts. Specific educational campaigns target children, adults, individuals with disabilities and small business owners. While it may be too early to judge how well the country has rebounded after the recent floods (though metrics such as debt-to-GDP and the employment rate indicate a positive trend), its post-COVID-19 success was testament to the extensive plans made at the company level on how to deal with emergencies. Indeed, the Slovenian economy contracted less than many of its peers in 2020 and rebounded strongly in 2021.5
To conclude this brief overview, we want to highlight the nature-based solutions for flood prevention that Slovenia implements, particularly when constructing new infrastructure. These solutions include the conservation and restoration of floodplains as well as sustainable forest maintenance, because forest cover reduces flood risk. Crucially, climate-change scenarios that inform infrastructure maintenance plans are prepared using the latest hydrological studies and expert assessments to remain relevant and maintain their accuracy over time.
What does this mean for investors?
Climate-change adaptation is clearly becoming increasingly necessary. For asset managers, it is imperative to know which issuers are well prepared for future risk events, as it will help determine the impact of extreme weather on creditor fundamentals. In the example of a sovereign issuer, this means how well prepared the population and infrastructure are for a crisis and how quickly (and at what cost) they can bounce back to full productivity. Slovenia knows how to minimize losses, which tells us as portfolio managers that the downside risks of climate change will likely be smaller for this country than for others less well prepared.
It is important to note that we are not advocating for investments solely in issuers that are not exposed to risk factors. In fact, that’s very difficult to do and would likely reduce return potential significantly. We simply believe that these risk factors must be understood and managed wisely.
A thorough understanding of the potential risks and relevant mitigation measures, as well as providing the necessary funding for the latter, help us safeguard our investments and create an opportunity to have a positive impact on the environment. This is impact investing at its finest: long-term credit resilience together with a beneficial contribution to our planet. Investing in green or climate-aligned bonds allows us to provide financing for biodiversity, renewable energy, climate-change adaptation and more. Through our involvement, we can potentially earn a compelling financial return, while helping to create a more sustainable future.
Endnotes
- Source: Fitch Ratings. As of November 2, 2023.
- Source: Gov.si. As of October 4, 2023.
- Source: SiStat. As of February 14, 2024.
- Sources: AR6 Synthesis Report: Climate Change 2023. Intergovernmental Panel on Climate Change. As of March 31, 2023.
- Source: SiStat. As of February 14, 2024.
WHAT ARE THE RISKS?
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Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Low-rated, high-yield bonds are subject to greater price volatility, illiquidity and possibility of default.
The manager may consider environmental, social and governance (ESG) criteria in the research or investment process; however, ESG considerations may not be a determinative factor in security selection. In addition, the manager may not assess every investment for ESG criteria, and not every ESG factor may be identified or evaluated. The managers’ environmental, social and governance (ESG) strategies may limit the types and number of investments available and, as a result, may forgo favorable market opportunities or underperform strategies that are not subject to such criteria. There is no guarantee that the strategy's ESG directives will be successful or will result in better performance.
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