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Climate change and investor returns
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A new report from Mercer that models the potential impact of climate change on investments has found investors can’t ignore the implications for investment returns.
The research reveals investors can manage the risk most effectively by looking ‘under the hood’ of their portfolios and factoring climate change into their risk modelling, which ‘requires a significant behavioural shift for most’.
The report, Investing in a time of climate change, outlines actions for investors to manage key downside risks and access opportunities.
It is the culmination of a research project that began in September 2014 and was launched in London this week (4 June), ahead of negotiations for a new global climate agreement at the end of 2015 in Paris.
‘This report highlights that investors should see the opportunities in addition to the risks from climate change. The tides are turning toward a low carbon future and away from the unsustainable status quo. Investment is needed to accelerate this unavoidable trend and those who are ahead of this trend, the report shows, may in fact better secure their financial future.
‘It is now time for us to make sure that our investments are safe for the long term; safe financially and safe for our precious planet.’
David Nussbaum, WWF-UK’s chief executive
The investment modelling in Mercer’s 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 2°C, 3°C and two 4°C scenarios (with different levels of potential physical impacts).
Mercer collaborated with 16 investment partners, collectively responsible for more than $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).
‘This is a landmark report. While it highlights the significant portfolio risks from climate change, it also shows that there are opportunities for long term investors in a low carbon world.
‘Climate change will impact investor returns under each of the climate scenarios modelled. Furthermore, it shows that the transformation scenario is not more costly to investors at portfolio level. This should give confidence to investors that they can advocate for strong climate policy action without sacrificing financial returns.
‘So, not only is climate change an urgent mega trend affecting our planet but it has profound investment implications for all investors. We hope the investment industry and global policy makers take note of these important findings, since we no longer have the luxury of time for inaction.’
Ray Dhirani, WWF-UK corporate stewardship manager on sustainable finance
Based on the scenarios modelled, Mercer says that climate change will ‘give rise to investment winners and losers’. The report warns that investors need to take action to understand and mitigate the risks.
‘Whilst it is challenging, we have attempted to quantify the potential investment impacts of climate change. 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.’
Jane Ambachtsheer, chair of Mercer’s Responsible Investment team
The average annual returns from the coal sub-sector could fall by anywhere between 18% and 74% over the next 35 years, with effects being more pronounced over the coming decade (eroding between 26% and 138% of average annual returns over the next 10 years).
Conversely, the renewables sub-sector could see average annual returns increase by between 6% and 54% over a 35 year time horizon (or between 4% and 97% over a 10-year period), depending on the climate scenario.