BACK TO SCHOOL
Despite these high profile announcements, many pension funds are still in the learning phase.
“Some pension funds are more advanced than others but the majority are behind the curve,” says Daron Sheehan, CEO of Active Earth Investment Management, an independent fund management company, which manages performance-driven funds that meet sustainable and responsible investment criteria. “Although the issues have been in the news for 20 years, I would say trustees are still in the educational phase.”
Aled Jones, head of responsible investment for Europe, the Middle East and Africa at Mercer, agrees, adding: “Broadly speaking, most investors do not factor climate change risks into their decision-making process. We have just published a study which aims to educate investors about the big changes that are to come and how they need to not only understand and mitigate the risks to their portfolio but also capture the opportunities. We adopted a scenario based approach, looking at a global average temperature rise of 2ºC, 3ºC, and 4ºC between pre-industrial times and 2050. This is because there were no standard investment models to do so.”
The report – Investing in a time of climate change – identifies four places where climate change will have an impact: resource availability (including droughts and flooding), disasters (extreme weather events), technological advances (reduction in greenhouse emissions from new tech development), and policy.
On the industry sector level, the analysis offers credence to the stranded asset argument. It predicts the coal industry will be the hardest hit, plummeting by as much as 74% in average annual returns over the next 35 years with the biggest drop occurring over the next decade. By contrast, renewable energies such as solar and wind energy could see returns jump between 6% and 54% over the same time horizon, or between 4% and 97% over a 10-year period, depending on the climate scenario.
A WEATHERPROOF PORTFOLIO
Some areas are not that straightforward. The fortunes of emerging market equities, infrastructure, real estate, timber and agriculture could go either way. They would benefit under a 2°C picture, but if temperatures rise to 4°C, they would lose their lustre due to chronic weather patterns – long-term changes in temperature and rainfall. Future regulation may also be a doubleedged sword. Carbon taxes, subsidies for green power or outright emission caps will make it more expensive for carbon-intensive industries, but there are question marks over the impact of subsidy cuts in the US, Germany, France and more recently the UK to the solar industry.
Given the backdrop, it is not surprising creating a weatherproof portfolio may be challenging.
“The first step is for institutional investors to take action now and not to ignore climate change because the future impact will be significant” says Nick Anderson, co-fund manager of Henderson Global Investors’ global care growth fund which has $700m assets under management. “They should look at the overall portfolio in terms of carbon emissions, not just in terms of the risks they can mitigate, but also to consider opportunities presented by companies helping to solve these issues.”
The next step is to look at the various options such as solar and wind infrastructure projects, specialist timber or a diversified real assets fund or green investment bonds, which only account for 0.2% of the fixed income market.
Currently, equities are the preferred option and this has been underscored over the past 18 months by a spate of low carbon indices being launched by index provider MSCI as well as asset management behemoths Blackrock and State Street Global Advisors.
“One of the main problems with tackling climate change is fund managers have short-term horizons while climate change is a long-term systemic problem,” says Emily Chew, vice president, ESG research at MSCI. “They want an appropriate framework and often cannot move far away from their benchmarks. Our global low carbon leaders indexes (based on the MSCI All Country World Index) filter out major carbon-emitting companies as well as large owners of carbon reserves, and then use a reweighting and optimisation strategy. The result is that we have reduced the carbon footprint by 50% with a low tracking error of 50 basis points.”
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