Investors should adjust their allocations dramatically to adapt to climate change, according to a new collaborative report.
The report was led by the consulting firm Mercer and involved 14 global institutional investors, and was supported by the International Finance Corporation, a member of the World Bank Group; and Carbon Trust. Grantham LSE/Vivid Economics led research on the economic impact of four climate change scenarios.
The report excluded “physical risks of climate change which are not consistently predicted by the range of scientific models,” according to Mercer. “This does not imply the absence of significant (and growing) risk.”
By the group’s estimates, uncertainty about the costs of climate change policy could contribute as much as 10% to portfolio risk between now and 2030. For example, government policy could increase the cost of carbon emissions by $8 trillion during the next two decades.
The cost of impacts on the physical environment, health and food security could exceed $4 trillion. Investment opportunities in low carbon technologies could reach $5 trillion, serving many investors, but add 1% in risk.
The United States is not leading the green wave; Europe and China and East are far ahead.
“Climate change brings fundamental implications for investment patterns, risks and rewards,” said Andrew Kirton, Chief Investment Officer at Mercer. The report recommends that institutional investors allocate up to 40% of funds to “climate-sensitive” assets, which include infrastructure, real estate, agricultural land, timberland, and green companies poised to benefit from change, for example, by developing carbon capture and storage systems. Although many of these “climate-sensitive” assets might seem risky now, they could ultimately decrease overall risk. An initial step might be to introduce climate-change risk assessment into reviews and take on some climate-sensitive assets as a hedge.
Floods in Australia and Pakistan and the wildfires in Russia have already led to “tens of billions of dollars in losses,” said Rachel Kyte, Vice President of the International Finance Corporation. “This study makes a significant contribution to our ability to measure the level of risk that climate change creates for investment portfolios,” she said.
Citing Mercer’s report, the Ceres investor coalition also announced that companies need to improve their disclosure of the climate-change risk they face. "Adjusting to a world profoundly shaped by climate change is a key challenge for all leading companies," said Ceres president Mindy S. Lubber. "Ensuring that investors are getting timely, material information on climate-related impacts, including regulatory and physical impacts, is essential.”
"As a long-term investor, we need a clear account of the environmental challenges and opportunities facing the companies we choose to invest in," added Anne Stausboll, chief executive officer of the California Public Employees' Retirement System, the nation's largest public pension fund, which contributed to the Ceres report.
The Ceres report comes a year after the Securities and Exchange Commission issued guidance for companies on climate-related information they should be disclosing to investors in their 10-Ks or 20-Fs, as well as quarterly filings.
Ceres cites examples of "good quality disclosure" in financial filings by Chiquita Brands International, Siemens, Rio Tinto, AES and Xcel Energy.
According to the group, investors need to know the impact of proposed or enacted carbon-reducing regulations on a company's direct and indirect operations; how more severe weather, rising sea levels, or shortage of farmland or water could affect the bottom line; how the company could benefit or suffer from demand for more energy-efficient products; and details on the company’s greenhouse gas emissions.
"Institutional investors everywhere are recognizing that climate change is a risk they must take full account of in their overall portfolios,” said Kevin Parker, global head of Deutsche Asset Management.
"Five years ago, it was unusual for any company to mention climate change in a financial filing, and few provided much more than a boilerplate acknowledgment that regulation of greenhouse gas emissions might at some point have a material impact on the company. Now, with expanded investor awareness of the financial impacts of climate change, investors are looking for more,” said Julie Gorte, senior vice president for sustainable investing at Pax World Management.
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