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Investment consultant Towers Watson enters stranded assets debate with advice for clients

Leading investment consultant responds to investors’ questions

Towers Watson, the investment consultant that advises more than 1,000 pension funds and institutional investors around the world, has entered the ‘stranded assets’ debate with a guide to help clients navigate fossil fuel investment issues.

The firm, which has more than $2trn (€1.75trn) of client assets under advice and which is also responsible for over $55bn of delegated and fiduciary assets worldwide, draws on work by the Carbon Tracker Initiative (CTI), the UK-based think tank which has done much to popularize the ‘stranded assets’ debate.

Towers Watson, which is responding to institutional investors’ queries on the issue, notes CTI’s assertion that there are more fossil fuels listed on the world’s capital markets than we are able to burn if catastrophic climate change is to be avoided.

“This is the crux of the stranded assets argument; this disparity does not appear to be fully priced in by the markets and thus current valuations of fossil fuel related companies may be incorrect,” the firm notes in a 14-page paper called ‘Fossil Fuels: Exploring the stranded assets debate’. Summarising the argument, it adds that the “magnitude of this disparity would suggest the risk of mispricing of fossil fuel assets exists”.

The firm stresses that its intention is not to prove or disprove the stranded assets argument. Rather, it is an attempt to consider the potential investment implications and suggest a framework to help institutional investors explore and respond to questions on fossil fuel investments.“These are the questions we hear institutional investors asking,” the firm says.

The firm categorises investor responses into four main groups (which are not mutually exclusive): Engage (with policy makers and companies), Adjust risk (e.g. low carbon indices), Divest and Hedge (e.g. invest in renewables and energy efficiency).

“These are the questions we hear institutional investors asking”

Renewable energy infrastructure is identified as a “natural hedge” for other exposures in the portfolio. Hedge funds too could take advantage of the stranded assets theme while re-insurance could also be “an interesting asset class from both a risk and opportunity perspective”. And there could be lasting impacts on the catastrophe bonds markets, Towers Watson reckons.

The paper suggests taking a similar approach to regulators’ banking stress tests: “Using a variety of scenarios an asset owner could consider how the portfolio would be positioned from a risk perspective in those situations.”

Fellow consulting firm Cambridge Associates looked at fossil fuels last year. Last July it advised
its clients to analyse their portfolios – at both the manager and portfolio level – for exposure to fossil fuel companies.