Mercer advocates massive institutional shift to climate sensitive assets

Results of major report in collaboration with leading investors

A major new study by consulting firm Mercer in collaboration with a group of 14 leading global investors with around $2trn (€1.37trn) in assets has recommended that institutional investors shift up to 40% of their assets into “climate sensitive” assets in order to mitigate environmental costs, which it says could increase portfolio risk by 10% over the next 20 years.
The study, which takes a novel look at the impact of climate change on asset allocation risks, defines climate sensitive assets as infrastructure, private equity, real estate, timberland, agriculture land, carbon, broad and sector focused sustainable equities and efficiency/renewable listed/unlisted assets.
“The analysis suggests that under certain scenarios, a typical portfolio seeking a 7% return could manage the risk of climate change by ensuring around 40% of assets are held in climate-sensitive assets,” the report says. “To manage climate change risks, institutional investors need to think about diversification across sources of risks rather across traditional asset classes.”
“Mitigating climate change risks will require a new approach for investors,” states the 132-page report entitled Climate Change Scenarios: Implications for Strategic Asset Allocation (downloadable here).
Mercer says the short-term horizon of traditional equity and bond investments means it will be more difficult for investors to price in long-term climate change risks in comparison with climate sensitive assets. It says the traditional way of managing risk, via a shift to a more conservative asset allocation, “may do little to offset climate risks”. The report says it could even result in a decline in returns. Conversely, the report says investment opportunities in low carbon technology could be as high as $5trn by 2030.
Mercer says selected investments in climate-sensitive assets could reduce portfolio risk in some scenarios.
Consequently, it says institutional investors’ interests could be aligned to both serve their beneficiaries’ financial interests as well as helping totackle climate change. The report outlines steps investors can take. They include undertaking a climate risk assessment, increasing climate sensitive assets as a hedge, using sustainability themed indices, and encouraging fund managers to manage climate risks and engage with companies on climate change disclosure.
The report was put together by a 29-strong Mercer team headed by Danyelle Guyatt with input from 19 other researchers including the Grantham Research Institute on Climate Change at the London School of Economics.
It used Mercer’s “TIP” framework, which stands for Technologies, Impacts and Policy. It analyses four different scenarios: regional divergence, delayed action, Stern action and climate breakdown.
“We think all pension funds will need to adopt a climate change-proofed financial investment strategy in the future to enable them to fulfil their fiduciary duties,” said Howard Pearce, Head of Environmental Finance and Pension Fund Management, Environment Agency. Andrew Kirton, Chief Investment Officer at Mercer, said: “Climate change brings fundamental implications for investment patterns, risks and rewards. Institutional investors should be factoring long-term considerations, such as climate change, into their strategic planning.”
Tom Fearnley, Investment Director at the Norwegian Ministry of Finance’s Asset Management Department said the report would provide input into its long-term strategy.
Investors involved in backing the report’s research included AP1, APG, AustralianSuper, British Columbia Investment Management Corp., BT Pension Scheme, CalPERS, CalSTRS, Environment Agency Pension Scheme, Government of Singapore Investment Corporation, Maryland State Retirement and Pension System, Norwegian Government Pension Fund, Ontario Municipal Employees Retirement System, PGGM and VicSuper.