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How to allocate assets to combat climate risk


Mercer’s extensive climate change report, launched today, gives investors a practical framework for monitoring and managing climate risk, shifting the discussion from philosophical agreement to practical investment implementation.


In Investing in a time of climate change Mercer outlines extensive dynamic investment modelling that analyses changes in the return expectations of assets between 2015 and 2050 driven by four climate change scenarios and four climate risk factors.

It looks at asset classes viewed through four risk factors that indicate the future implications of climate change: technology, resource availability, impact and policy.

Helga Birgden the recently appointed global business leader of Mercer’s responsible investment business, says the report gives investors a concrete, practical outcome for dealing with climate risk.

“It is critical as far as we are concerned, to have the tools and practical support to help asset owners,” she says.

Naturally, the report concludes that climate change will have an effect on investment returns so climate risks should be viewed as a new return variable. But the granular analysis of this year’s report shows the impact will be most meaningful at the industry level, giving investors clearer strategies on how to deal with the portfolio implications.

In particular average annual returns from the coal sub-sector could fall by anywhere between 18 and 74 per cent over the next 35 years, with the next 10 years seeing the biggest impact with average annual returns eroding between 26 and 138 per cent.

Conversely the renewables sub-sector could see average annual returns increase by between 6 and 54 per cent, or between 4 and 97 per cent over the next 10 years.

The impact on asset class levels depends on the climate scenario that unfolds. A 2 degree scenario would benefit emerging market equities, infrastructure, real estate, timber and agriculture. But a 4 degree scenario presents a different outcome for the same asset classes.

The report advises positioning investor portfolios to access the positive return assets, and minimising risk exposures to those where there will be negative impacts.

Mercer adopted a collaborative approach in developing the report, including input from 16 asset owners and asset managers, including CalSTRS, AP1, Cbus, New Zealand Super, and New York State Common Retirement Fund.

“As a long-term, intergenerational investor, we need to understand the investment risks and opportunities associated with climate change. This study will help us calibrate our investment strategies accordingly,” Adrian Orr, chief executive of New Zealand Super said in the report.

Mercer’s Birgden says the report discovered that investors need to look under the hood.

“The report found that the issue of climate change as a systemic risk is most prevalent at the asset sector level,” she says. “The report provides investors with a story to focus on. Climate is so large and complex it requires a clear focus on what to do.”

The report, which is a follow up to the 2011 study and the follow up paper, Through the Looking Glass, is a more granular analysis of the climate risks looking at sectors and subsectors and the potential asset allocation implications. It also looks in more depth at the physical impact of catastrophic events.

“This requires a change of behaviour as investors need a line of sight,” Birgden says. “It will mean governance change much closer engagement with managers, as well as a framework for the mainstream monitoring of these issues.”

“This is a story about sustainable growth and how asset owners can identify their footprint, reduce coal exposure, and invest in a transition to low carbon.”


The report was sponsored by the IFC World Bank Group and the UK Government.

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