Example portfolio mix across climate-change scenarios, with portfolio to target 7 percent return. Source: Mercer

By Mike Foster
21 Feb 2011

Institutional investors need to shift 40% of their portfolios into climate-sensitive sectors, including infrastructure and agriculture, to safeguard returns against the impact of global warming, according to consultant Mercer.

Mercer is the biggest investment consultant in the world. Its approach, backed in a report by global institutions managing $2 trillion, marks a radical shift of attitude towards climate change by institutions from governance to mainstream investment thinking.

Its 40% recommendation, designed to preserve a 7% a year return, is the result of a sophisticated investment modelling technique that Mercer will introduce to its clients this year. Using advice from the Grantham Research Institute, it has calculated that weather extremes, for example leading to floods and food shortages, could contribute 10% to portfolio risk by 2030.

As well as environmental damage, which many scientists believe will become extreme after 2050, Mercer says schemes need to anticipate policy changes designed to alleviate the problem. It said investors should concentrate on three factors: energy efficiency and technology; changes to society, such as health and food security; and shifts in policy, particularly in carbon dioxide emission control.

Mercer’s head of responsible investment in Europe, Will Oulton, said schemes would want to make their own decisions on how far they want to incorporate 40% climate protection into their portfolios.

But in its report – Climate Change Scenarios: Implications for Strategic Asset Allocation – Mercer says the time has come for climate hedging to begin. It suggests a higher allocation to climate-sensitive real estate, infrastructure, private equity, sustainable equity, renewable and commodity opportunities – all of which can produce returns regardless of climate change.

These changes, if put into practice, would also speed up diversification away from the traditional equity/bond split.

At a Mercer climate conference last week, Howard Pearce, head of pension management at the UK’s £1.7bn Environment Agency pension scheme, said his trustees have raised their exposure to climate-sensitive assets from 2% in 2002 to 13%. They are debating lifting the allocation to 25% by 2015.

Pearce said a range of options could be used, including investment in water and mass transit systems, to slot alongside sustainable portfolios managed by Robeco and Sarasin. He said managers should create absolute return funds: “They could put the climate factors together into a single product.”

Helene Winch, head of policy at the £34bn BT pension scheme, said her trustees have been carrying out a great deal of “very scary” scenario planning: “There is a very real risk that climate change will impact all our assets.” …

Climate change will force 40% shift in asset allocation



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