Institutional investors around the world should build climate-change risks into their asset allocation and risk management processes and urge policymakers to act quickly to curb emissions, according to a new report by Mercer.
Investors should broaden their approaches to include an awareness of risk factors and include climate-sensitive investments such as those in infrastructure and sustainable equities in their asset allocations, Danyelle Guyatt, principal and global head of research, responsible investment at Mercer, said at a client conference on the report Tuesday in London.
“There is an increased source of risk from climate change, and it could be material,” Ms. Guyatt said.
Breaking down a typical U.K. pension fund asset allocation of 50% equities, 40% fixed income and 10% real estate, Mercer found the risk-factor exposures include 10% to climate policy risk and 1% to climate technology risk. Ms. Guyatt suggested investors would benefit from diversifying away from the equity risk premium, and boost exposure to climate technology risk — the risk of a technology becoming obsolete — while curbing exposure to climate policy risk — the risk of a country suddenly imposing a tax, tariff or other measure that affects an investment.
By overlaying asset allocation data from 14 worldwide pension and sovereign wealth funds on four climate-change scenarios, Mercer was able to show how certain environmental and policy variables might affect investments over long-term horizons.
“There has been a reasonable amount of research around what climate change might mean for particular companies (or) sectors … but what we didn't have was something that looked at what it meant (more broadly) for asset owners,” said Bruce Duguid, head of investor engagement at the Carbon Trust, one of the report's sponsors.
He added some investors might be surprised to learn that the way to address climate risk is by investing in climate assets, which are “at the moment, seen as risky assets, so you actually address (climate) risk by adopting what might be seem to be a greater risk profile.”
In the report, Mercer found that over the next 20 years:
• climate change policy risk could boost portfolio risk by 10 percentage points;
• impact of climate change on the environment, health and food security could cost $4 trillion, and policy changes worldwide could boost the cost of carbon emissions by as much as $8 trillion; and
• investments in low-carbon technology could reach $5 trillion.
“Mercer's suggested realignment toward climate-sensitive assets is smart advice for investors looking to minimize risks and maximize benefits from climate change's vast investment opportunities,” Mindy S. Lubber, president of the environmental investment organization Ceres and director of the Investor Network on Climate Risk, said in a news release in response to the report. “Yet for a truly effective investment response, policymakers and regulators must ensure that investors have the information they need from companies to make prudent investment decisions.”
The INCR is a group of 95 institutional investors that represent more than $9 trillion in assets.
Sean Kidney, London-based manager at environmental consultant Climate Risk Europe, said at the Mercer client meeting that the report's estimates of the impact of climate change are “very conservative,” and the estimates would be much worse if secondary impacts could be modeled.
What's needed is for institutional investor groups to proactively lobby governments to adopt climate change policies, Mr. Kidney said.
“The longer the policy delay, the higher the impact costs will be for investors,” according to the Mercer report, “Climate Change Scenarios — Implications for Strategic Asset Allocation.” “It is therefore crucial for institutional investors to engage with policymakers on the specific details of policy plans and measures as part of their risk management process, to help protect and enhance the long-term value of the assets they oversee,” the report said.