<!-- Swiftype Variables -->

Special Report

Investors move to limit impact of climate change on their portfolios

The ripple effects of fossil-fuel prices on investment portfolios look set to diminish as the ranks of institutional investors striving to make their portfolios resilient to climate change risks grow.

Analysts say the past year or two have seen climate-related risks move from the periphery toward the center of investor radar screens, driven by policy — including the landmark 2015 Paris accord pledging governments to limit the rise in global temperatures to 2 degrees Celsius — and the growing competitiveness of wind and solar power.

The momentum behind investor moves to address climate-related risks and opportunities in institutional portfolios should continue to build, even with U.S. President Donald Trump's June 1 decision to bolt from the Paris accord, industry watchers predict.

The reality is the economics of renewable energy sources, such as wind and solar power, are improving relentlessly, and that will leave conventional, more polluting segments of the market “in a less competitive position” regardless of what Mr. Trump does, said Ben Caldecott, director, sustainable finance program, at the University of Oxford's Smith School of Enterprise and the Environment.

The April release of the latest annual report on global trends in renewable energy investment by the United Nations Energy Program and Bloomberg New Energy Finance reported that investments in renewables, led by wind and solar power, came to $241.6 billion in 2016, or 55% of all energy-related investments — the fifth year in a row that investments in renewables outpaced investments in fossil fuel-based power facilities.

That “convergence of technology and policy” has brought institutional investors to an “inflection point” in addressing the opportunities as well as the risks resulting from significant disruption in energy markets, said Mathew Nelson, Melbourne-based global and Asia-Pacific climate change and sustainability services leader with Ernst & Young, in an interview.

Asset owner responses to such risks include “hard and fast” divestment strategies; “engaging strongly” with companies and focusing on companies set to benefit from the transition to a low-carbon economy, said Emma Herd, Sydney-based CEO of Australia's Investor Group on Climate Change.

Investors say they're looking to make their portfolios more resilient to the fallout should governments take steps to honor the Paris agreement's 2-degree target. Such steps could leave big energy companies saddled with “stranded assets” — fossil fuel reserves on their books that could lose value if the reserves couldn't be used without breaching that temperature ceiling.

Asset owners moving over the past year or so to cut their exposure to fossil fuels have included:

  • the A$37 billion ($27.5 billion), Melbourne-based Health Employees Superannuation Trust Australia, which adopted a passive global equity strategy in April 2016, developed with Russell Investments, targeting carbon dioxide emissions and carbon reserves of 50% below its benchmark;
  • London-based HSBC Bank U.K., which over the past seven months put more than 4 billion ($5 billion) in defined contribution and defined benefit assets in a Legal & General Investment Management strategy tilted to companies with renewable energy revenues and away from high-carbon companies; and
  • the 1.3 billion London-based National Employment Savings Trust, which in February added a “climate aware” global equities fund developed with UBS Asset Management, targeting a 50% cut in “carbon intensity” by tilting toward renewable energy companies and away from high carbon companies.

Others asset owners are poised to put broader programs in place.

Matt Whineray, chief investment officer of the New Zealand Superannuation Fund, Auckland, said his NZ$34.6 billion ($24.4 billion) fund will move in coming months to address the “uncompensated risks” posed by climate change, with a focus on reducing the portfolio's exposure to emissions and fossil fuel reserves.

More than 90% of those reserves come from the 13% of the global equities benchmark accounted for by energy and materials companies, and trimming that exposure could affect a few percentage points of the portfolio, Mr. Whineray said. Broader climate change risks include regulatory changes, physical damage from weather events and disruption to supply chains, he said.

In addition to reducing exposure to high-risk listed assets, engaging with companies to promote better disclosure of the climate change risks they face and identifying winners from a low-carbon environment to invest in, the final focus of New Zealand Super's strategy will revolve around analysis, said Mr. Whineray: “How do we incorporate climate change risk in the way we think about valuations, risks and investment hurdles?”

Money managers say that challenge — of taking the long-term impact of climate change into account — doesn't have easy answers at present.

With few exceptions, it's “not easy to see how climate risks are priced into assets today,” noted Steffen Horter, Frankfurt-based global head of ESG with Allianz Global Investors GmbH.

Meanwhile, obtaining disclosures from companies about the risks their businesses face from climate change remains a work in progress.

A recent survey for Ernst & Young of 320 institutional investors globally, released in April, found much greater attention to issues like climate change, coupled with frustration that they weren't “getting the information they need to make nuanced investment decisions,” said Mr. Nelson.

“The level of disclosure from companies is still pretty much in its infancy,” noted Andrew Gray, senior manager, investments governance, with A$100 billion AustralianSuper, Melbourne. That adds to the challenges of crunching climate risk-related numbers, when the direction of likely changes is clear but the timing is uncertain, he said.

The release of a final report by the Task Force on Climate-related Financial Disclosure led by former New York Mayor Michael Bloomberg, slated for the end of June, could go a long way in setting the stage for progress on that score, some market veterans said.

The Financial Stability Board set up the task force at the end of 2015 as an industry-led initiative to come up with recommendations for consistent, comparable, reliable, clear and efficient climate-related disclosures by companies.

The report could be “a really significant milestone,” providing businesses with “a framework for understanding how to manage (climate change) as a business issue,” said Ms. Herd of the Investor Group on Climate Change.

“Asset owners, public companies, investors and regulators want more information” in analyzing climate-related risks and opportunities. The TCFD report “is an important step toward that goal,” agreed Bruno Bertocci, a Chicago-based managing director with UBS Asset Management and senior portfolio manager for the firm's global sustainable equity strategy.

Some observers are less optimistic on that score.

Disclosure is all well and good but the vast bulk of what asset owners are getting now isn't “fit for purpose,” contended Mr. Caldecott. “Too often people conflate disclosure with data,” he said.