An increasing percentage of European pension funds are now taking climate-change risk into account when it comes to investment allocations, with awareness of ESG-related risks also on the rise.
Consultant Mercer's latest European asset allocation insights survey found that 54% of respondents actively consider the impact of climate change-related risks on their investments, up from 14% in a 2019 survey.
Further, 89% of pension funds now consider wider environmental, social and governance risks as part of their investment decisions, up from 55% last year.
While regulation remained a concern for investors when it comes to ESG-related risk, the proportion worried about the potential impact on investment returns grew to 51% from 29% last year. A desire to mitigate potential reputational damage was cited as a reason to consider ESG risks by 40% of respondents, and 30% want to align their investment decisions with their sponsoring company's existing corporate responsibility strategies, a report of the survey results said.
Mercer surveyed 927 institutional investor clients with total assets of about €1.1 trillion ($1.3 trillion). Respondents were surveyed in the fourth quarter and early in the first quarter.
Other findings included a continued move away from equities, with an average equity holding of 22% vs. 25% last year. The proportion of respondents investing in fixed-income grew 10 percentage points to 47% in the 2020 survey, while those investing in real assets grew 4 percentage points to 53%. The proportion of European pension funds investing in private equity also grew, to 14% from 8% in the 2019 survey.
While European pension funds are moving away from equities in general, those sticking with the asset class are diversifying within allocations. Exposure to emerging markets increased to 43% from 34%, small-cap equity allocations grew to 21% from 12% and investment in low-volatility equities increased to 17% from 7% in 2019's survey.
Currency hedging also increased over the year, with 42% of investors hedging more than 60% of their foreign currency exposure in public equity portfolios. That compared with 26% of investors hedging more than 60% in 2019.
Mercer's data were collected prior to the onset of the COVID-19 pandemic. "The long-term impact of COVID-19 is yet to play out; in many aspects, the effects are sectoral as opposed to necessarily asset class-based," said Jo Holden, European director of strategic research, in a news release accompanying the report. "Going forward investors are likely to look for opportunistic investment in distressed assets, potentially in real estate and in private market secondaries. However, the institutional investor base rely on long-term strategic asset class mixes and are unlikely to 'bet the farm' on tactical plays."
The report is available for download from Mercer's website.