Legislative and regulatory uncertainty about climate policy help contribute an average 11% to investment portfolio risk, according to a Mercer report, released Wednesday.
Policy uncertainty alone accounts for 10% of the portfolio risk, while 1% comes from exposure to technology related to climate-change mitigation.
Investors can exploit sources of risk and opportunity associated with climate change by embedding climate change risk in their asset allocation process, according to the report, “Through the Looking Glass: How Investors Are Applying the Results of the Climate Change Scenarios Study.”
The “best way to manage portfolio risk associated with climate change while retaining similar levels of overall risk and return is to increase exposure to those assets that have a higher sensitivity to climate change” risk factors in policy, technology and physical damage impacts, the report said.
These assets include sustainability-themed, renewable energy-driven and other resource-driven investments in equities, timberland, farmland, infrastructure, private equity and real estate, among other asset classes. “These assets will likely capture the great opportunities” but also face the greatest risk from climate inaction, the report said.
A Mercer survey based on the responses of 12 of 14 major global pension funds and institutional investors participating in its analysis found one-third of them have decided to allocate to more climate-sensitive assets, while half of them may do so, the report said.
Among other findings, half of the respondents plan to include climate change considerations in risk management or strategic asset allocation processes or both, while 40% have not decided whether they will change such processes.
Mercer's work “provides a model for investors to understand climate change risk in their portfolios and build resiliency in their portfolios by seeking to decrease or increase those risk factors,” Ryan Pollice, Mercer analyst, said in an interview.
The investors surveyed were the California Public Employees' Retirement System, California State Teachers' Retirement System, Maryland State Retirement Agency, Ontario Municipal Employees Retirement System, British Columbia Investment Management Corp., British Telecom Pension Scheme, All Pensions Group, AP1, AustralianSuper, Environmental Agency Pension Scheme of the United Kingdom, Government of Singapore Investment Corp., Norwegian Government Pension Fund, Australia's VicSuper Pty Ltd. and PGGM Investments.