Investors Must Factor Climate Change in Their Portfolio Risk: Mercer Study

By and | June 5, 2015

Most investors need to make a significant behavioral shift and start factoring climate change into their portfolio risk management, a study on its impact on financial market returns found.

Government officials are meeting in Germany this month to work on a global deal to cut greenhouse gas emissions due to be agreed in six months’ time in Paris. There is increasing debate about the impact of climate change on investments, particularly in fossil fuels.

A study by consultants Mercer – backed by the International Finance Corporation, the World Bank’s private sector arm, and British and German government development units – modeled a range of outcomes on the impact on a range of assets and sectors out to 2050 under four temperature change scenarios.

For good or bad, climate change would impact investment returns and ignoring it was not a savvy option, the report said, although for long-term diversified investors, a 2 degree temperature increase would not result in negative returns.

“This new study led by Mercer could not be more timely on the road to the UN climate change conference in Paris,” said IFC Director for Climate Change Christian Grossman.

“It can also send a clear message to policy-makers that resolving the uncertainty around the policy direction of carbon pricing will be an important first step toward transitioning to a low carbon economy,” he added.

On Monday, Europe’s top oil and gas companies urged governments around the world to introduce a pricing system for carbon emissions.

But prospects are fading for a global deal that would keep average temperatures below a 2 degree Celsius rise, which scientists say is the limit beyond which the world will suffer ever worsening floods, droughts, and rising seas.

The biggest risk, in terms of differentiation between winners and losers, is at the industry level, the report said, citing the example of the coal industry, where average annual returns could fall as much as 74 percent over the next 35 years.

Over the same period, meanwhile, renewable energy average annual returns are seen between six and 54 percent.

At the asset allocation level, a 2 degree scenario would see return benefits for emerging market equities, infrastructure, real estate, timber and agriculture, while a 4 degree scenario could see much of that reversed.

“Institutional investors require actionable information to adequately reflect climate risks and opportunities into asset allocation. While global warming is a fact, we face great uncertainty around policy measures and the financial impacts in the nearer term are little understood,” said Karsten Löffler, Managing Director, Allianz Climate Solutions GmbH.

“The Mercer study … could become a standard toolbox for strategic asset allocation.”

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