A new report from Mercer says investors need to factor climate change into their risk modelling as the implications for investment returns are too significant to be ignored.
The report, titled Investing in a time of climate change
, is the culmination of nine months’ work and is released ahead of negotiations for a new global climate agreement at the end of 2015 in Paris.
While the findings are designed to better inform investment risk and opportunity priorities, the company said it can also be used as a tool to engage business leaders on the subject.
The report estimates the potential impact of climate change on returns for portfolios, asset classes and industry sectors between 2015 and 2050, based on four climate change scenarios and four climate risk factors.
The four scenarios represent a rise in global temperature above pre-industrial era temperatures of 2C, 3C and two 4C scenarios with different levels of potential physical impacts.
Chair of Mercer’s Responsible Investment team, Jane Ambachtsheer, said the report had attempted to quantify the potential investment impacts of climate change, which was not without its challenges.
“We recognise that markets do not always price in change; they are notoriously poor at anticipating incremental structural change and long-term downside risk until it is upon us.
“Our report identifies the ‘what?’, the ‘so what?’ and the ‘now what?’ in terms of the impact of climate change on investment returns. These insights enable investors to build resilience into their portfolios under an uncertain future.”
A key finding of the report, which follows on from Mercer’s 2011 study and follow-up paper Through the Looking Glass
, indicated that the biggest risk would be at the industry level.
For example, depending on the climate scenario which played out, the average annual returns from the coal sub-sector could fall by anywhere between 18-74% over the next 35 years, with effects being more pronounced over the coming decade. Conversely, the renewables sub-sector could see average annual returns increase by between 6-54% over the same period.
Ambachtsheer said the report could act as a guide to creating an action plan.
“Whether it is setting portfolio decarbonisation targets, investing in solutions that address risks and opportunities, or increasing engagement with managers and companies, our report shows investors how they might take action.
“Engaging with policy makers is also crucial and helps empower investors in their role as ‘future makers’,” she said.
Mercer, which is a wholly owned subsidiary of Marsh
& McLennan Companies, collaborated with 16 investment partners collectively responsible for more than US$1.5 trillion to produce the report.
It was supported by IFC, the private sector arm of the World Bank Group, in partnership with Federal Ministry for Economic Cooperation and Development, Germany, and the UK Department for International Development (DFID). The study was also supported with contributions from Mercer’s sister companies NERA Economic Consulting and Guy Carpenter and input from 13 advisory group members.
Mercer’s Global CIO for Mainstream Assets, Russell Clarke, said the study would help with navigating changes that such a structural and systemic issue as climate change may represent.
“We believe it’s a significant investment risk that investors should be aware of and able to act upon in close collaboration with investment managers.
IFC director for climate change, Christian Grossman added: “It can also help send a clear message to policy makers that resolving uncertainty around the policy direction of carbon pricing will be an important first step toward transitioning to a low carbon economy.”
Karsten Loffler, managing director of another investment partner, Allianz
Climate Solutions GmbH, was unequivocal.
“While global warming is a fact, we face great uncertainty around policy measures and the financial impacts in the nearer term are little understood.
“The Mercer study is an important step in channelling scientific and regulatory insights on climate change into the investment process and could become a standard toolbox for the strategic asset allocation.”
The report can be accessed here