How trustees can tackle climate investment risks

Trustees need practical guidance on how to implement a comprehensive investment approach to climate change. Helga Birgden, head of responsible investment for Asia Pacific at Mercer and Nathan Fabian chief executive of the Investor Group on Climate Change Australia/New Zealand,  show them how.

In the 2013 Global Investor Survey on Climate Change, more than 80 per cent of asset owners such as pension funds identified climate change as a material investment risk. Despite this only 25 per cent said they had changed their investment strategy or decisions as a result of their risk assessment. While leading pension funds are making changes, many trustee boards are yet to implement a comprehensive investment approach to climate change.

To address this implementation gap, IGCC and Mercer recently filmed real life trustees in a role-play of a board meeting of the fictitious Perfect Storm Pension Fund.

The aim was to discuss and agree concrete steps a trustee board could take to address climate investment risk. Seven areas were discussed in the form of board resolutions on: investment policy; strategic review; investment tradeoffs and timing; increasing climate sensitive allocations; measuring investment exposures; and disclosing performance to the market.

Each area is discussed below and the meeting videos and resolutions can be viewed here.

Investment Policy: Explicitly addressing trustee investment beliefs on climate risk in the Investment Policy Statement or in a separate ESG Policy is a necessary first step to activate the fund stakeholders and its service providers around the challenge of climate change.

A widening of the investment lens to focus on protecting a portfolio and enhancing opportunities by opening access to growth is what is required. Investment beliefs need to be driven by evidence, conviction and reasonable consensus. Addressing the relationship between climate change and fiduciary duty, corporate governance and the materiality of environmental and social issues to company performance depends on it. The evidence of climate related economic risk, government policy and technology change is more comprehensive than ever. Many leading funds have taken this step already.

Strategic Review: In the strategic review, both near and long term impacts from climate change on existing investments across asset classes, regions and sectors should be reviewed.

Information for the review can be gained from research and analysis via fund collaborative research studies, from research conducted by the fund’s portfolio management teams, asset managers and specialist advisors. Strategic asset allocation and portfolio reviews tabled at board meetings allow trustees to participate in the consideration of systemic risk factors which may be material to the overall fund’s performance and its investment strategy.

Tradeoffs and timing: Next, tradeoffs between climate impacts and mitigation pathways should be assessed and assumptions built in to mandates.

Less mitigation action by governments, businesses and investors will mean worse climate impacts. Strong mitigation steps may avoid the worst climate impacts, but will change investment returns from emissions intensive activities.

The important questions are whether physically vulnerable assets are at risk, whether emission intensive assets and related supply chains are at risk, or both? While investors are not scientists there is sufficient information available for investors to make a judgment about how climate and regulatory impacts will play out and position their fund accordingly. Some public company boards are embracing this conversation on tradeoffs in their strategy and capital deployment activities.

Investment allocations: To implement policy means allocating capital.

There are a number of ways that leading funds consider allocation, including risk mitigation at the portfolio level and identifying growth opportunities in sustainability related sectors and markets. The former includes how managers address climate risk and opportunity within their investment framework, the latter how managers are gaining exposure to various themes and new ideas to capture revenue and alpha opportunities in responding to climate change.

Pension funds can also allocate to environmental themes by focusing on solutions to environmental problems and resource scarcity, for example in renewable energy, energy efficiency and clean technology, water and waste management and agriculture.

Environmental themes can be accessed through either pure play investment strategies, which focus on one particular theme such as energy, or through a broader approach, combining various environmental themes. There are now many options for pension funds to allocate capital to climate sensitive activities in public and private equity, in fixed income, infrastructure and real estate.

Measuring exposure: Forming good investment strategy relies on good information. Analysing exposure to greenhouse gas emissions and to low carbon assets is the first step in a necessary internal review by pension funds.

The questions that such analysis should provoke include how to best assess the risk and return implications of reducing emissions exposure and whether hedging against climate impacts can occur while maintaining returns. Without asking these investment questions or being prepared to change allocations, portfolio footprinting is a solitary step that has provided limited benefit to the funds that have performed it.

Disclosure: Finally, investors rely on well functioning markets. Low transaction costs and high deal flow rely on high quality and available information.

It is in the self-interest of pension funds to create a market for emissions reduction investment opportunities and encourage more low carbon deal flow and business activities. Disclosing carbon exposures of funds will help to develop a market for responses to these problems. Disclosing exposure by using emerging metrics on financed emissions will provide more information for markets and options for funds to respond to climate risk. Disclosing information about low carbon investments will also help the market to develop more of the opportunities that funds favor and less of those that they don’t.


A trustee board that implements each of these steps will be making climate sensitive investment decisions in practice.

Difficult tradeoffs will still need to be assessed, but the necessary information and tools are now available to guide trustee boards.

The science of climate change is relatively clear, the economic impacts are well understood and the quality and quantity of investment analysis is reaching investment grade. While some uncertainties remain on government policies, changes in markets and future technology trends, these issues should be addressed at the tactical investment level, rather than at the strategic level by trustee boards.

Given that so many pension funds already identify climate change as a material risk, following through with a comprehensive investment approach is the necessary and prudent response. The seven example resolutions discussed by the Perfect Storm Pension Fund Board can provide the basis for a comprehensive response to climate change by pension fund trustees.

The Perfect Storm Pension Fund board meeting role-play can be viewed here.


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