Study led by Mercer determines that continued delay in climate change policy action could cost institutional investors trillions of dollars

February 17th, 2011 by Mercer

On 15 February 2011 Mercer’s Responsible Investment (RI) team launched “Climate Change Scenarios – Implications for Strategic Asset Allocation” which finds that:

  • Climate change could contribute as much as 10% to portfolio risk over the next 20 years
  • Investors could benefit from increased allocation to infrastructure, real estate, private equity, agriculture land, timberland and sustainable assets
  • Investment opportunities in low carbon technology could be as high as $5 trillion by 2030
  • Institutional investors have numerous options for capitalising on opportunities and managing risks arising from climate change

Continued delay in climate change policy action and lack of international coordination could cost institutional investors trillions of dollars over the coming decades, according to research released by Mercer and a group of leading global investors representing around $2 trillion in assets under management.

Andrew Kirton, Chief Investment Officer at Mercer, commented: “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. Mercer is pleased to have had the opportunity to kick start such strategic discussions with a group of leading global investors.”

The report “Climate Change Scenarios – Implications for Strategic Asset Allocation” analyses the potential financial impacts of climate change on investors’ portfolios, identified through a series of four climate change scenarios playing out to 2030. The report identifies a series of pragmatic steps for institutional investors to consider in their strategic asset allocation.

In the report, a framework is outlined that can be used by institutional investors to enhance their understanding of climate-related investment risks and opportunities across asset classes and regions. Mercer’s “TIP Framework” estimates the rate of investment into low carbon technologies (T), the impacts (I) on the physical environment and the implied cost of carbon resulting from global policy (P) developments across the four climate scenarios.

Some of the key findings show that by 2030:

  • Climate change increases uncertainty for long term institutional investors and as such, needs to be pro-actively managed.
  • Investment opportunities in low carbon technologies could reach $5 trillion.
  • The cost of impacts on the physical environment, health and food security could exceed $4 trillion.
  • Climate change related policy changes could increase the cost of carbon emissions by as much as $8 trillion.
  • Increasing allocation to “climate sensitive” assets will help to mitigate risks and capture new opportunities.
  • Engagement with policy makers is crucial for institutional investors to pro-actively manage the potential costs of delayed and poorly co-ordinated climate policy action.
  • Policy developments at the country level will produce new investment opportunities as well as risks that need to be constantly monitored.
  • The EU and China/East Asia are set to lead investment in low carbon technology and efficiency improvements over the coming decades.

(click on report cover to go to Mercer website)

The launch of the report and the Mercer TIP Framework represents a collaborative endeavour led by Mercer which involved 14 global institutional investors, and was supported by the International Finance Corporation, a member of the World Bank Group, and Carbon Trust. Grantham LSE/Vivid Economics were engaged to lead components of the research on the economic impacts of climate change scenarios and a research group comprised of industry practitioners and academics was consulted in the development of the model.

Commenting on this report, Rachel Kyte, Vice President, IFC, said “that climate change poses significant financial and economic risks has only been accentuated by the tens of billions of dollars in losses due to recent climate related natural disasters such as the floods in Australia and Pakistan and the wildfires in Russia. This study makes a significant contribution to our ability to measure the level of risk that climate change creates for investment portfolios. Managing that risk in a way that maintains the returns expected by beneficiaries is a crucial responsibility for the management of these investment portfolios. This report provides some practical steps that investors can take today to shift their asset allocation to manage climate change risks and finance the much needed infrastructure for a lower carbon future.”

Bruce Duguid, Head of Investor Engagement, The Carbon Trust, said “this report is unique and ground-breaking in quantifying the increased portfolio risk arising from global efforts to tackle climate change. It demonstrates that unless this risk is tackled intelligently by increasing exposure to climate sensitive assets, then long term rewards could fall. The findings undermine the notion of a conflict between ‘green’ investing ‘ and acting in beneficiaries long term financial interests. This will have profound implications for fiduciary duties and places a clear obligation to increase analysis of the consequences of climate change for portfolio management.”

Howard Pearce, Head of Environmental Finance and Pension Fund Management, Environment Agency, said “why does climate change matter to institutional investors like the Environment Agency pension fund? It matters because we know that we will need to be paying out pensions to our fund members well into the 21st century. 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. We also want our pensioners to retire into a similar environment than we enjoy today and not one that is affected by the extremes of climate change that could reduce their life expectancy.”

Tom A. Fearnley, Investment Director, Norwegian Ministry of Finance, Asset Management Department, said “climate change is a global risk factor that all long term investors should take into account when formulating investment strategy. This in-depth analysis will provide valuable input to our long term strategy reviews.”

Doug Pearce, CEO/CIO for British Columbia Investment Management Corporation (bcIMC), said “in early 2010, we set a goal to better understand how climate change could be factored into our broad investment actions. For example, should the risk and return impacts of global warming modify our allocation between and within asset classes? The Mercer study has helped clarify our thinking on some of these uncertainties. In our view, the report makes an original contribution by giving financial meaning to recognized climate science (Stern, IPCC) and provides ideas on constructing portfolios acknowledging climate trends. It also raises many more questions and hopefully will stimulate additional in-depth work around investment capital and climate change.”

Joe Dear, CIO, CalPERS, said “CalPERS has been a leading advocate for environmental and climate change issues for many years and recognizes these to be key risks for long term investors. This opportunity to collaborate with institutional investors from around the world to look at the impact of climate change scenarios on investments helps us to shape our strategic thinking in this area and better integrate our programs, policies and risk management.”

Jaap van Dam, Managing Director Strategy, PGGM Investments, said “this project has given us insight into the complexity of the effects climate change could have on the risk and return of our portfolio. Climate change proves to be a source of uncertainty. Although there is currently no straightforward answer to manage this uncertainty, we will continue to address this issue in our investments activities.”

Johan Magnusson, Managing Director of Första AP-fonden (AP1), said “participating in this project has not only given us better insight of what impact climate change could have on asset classes and the long term performance of our portfolio. It has also given us enhanced tools for our strategic asset allocation analysis.”

Peter Lunt, Head of Investment Research, VicSuper, said “VicSuper has taken an active position in integrating sustainability into its investment strategy. This has involved investing in low-carbon equity funds such as the Vanguard Carbon Aware International Shares Fund, as well as in venture capital clean technology which in turn invests in technology and products providing solutions to environmental challenges. Our participation in this Climate Change Scenarios report has assisted our thinking in how to integrate climate change risk and opportunity into our investment strategy, and also in ways to access a robust and defensible methodology to assess the possible risk and return implications of climate change. We do this for the benefit of our more than 250,000 members.”

1 Whilst the UN climate change talks in Cancun produced some agreement on reforms that failed to materialise during preceding discussions at Copenhagen, the absence to the future of market based mechanisms post 2012 when the Kyoto Protocol expires creates a cloud of uncertainty over investors’ heads.

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