Climate change is set to significantly impact investment returns and investors should adapt portfolios to mitigate the risks, a report has warned.
The report, published by Mercer in collaboration with 16 investment partners, modelled the potential impact of climate change on portfolio returns between 2015 and 2050, based on four climate change scenarios representing different rises in global temperature above pre-industrial era temperatures: two degrees, three degrees and two scenarios at four degrees.
Based on the two degrees scenario, Mercer found for a sample portfolio over a 10-year period, the median annual return impact was 0.73% for infrastructure, 0.58% for agriculture, 0.5% for emerging market global equities, 0.47% for timber and 0.45% for real estate.
However, for developed market equity and private equity, the impact was -0.82% and -0.83%, respectively.
The report also found the average annual returns for sub-sectors varied wildly depending on which scenario played out. For example, the coal sub-sector could fall between 18% and 74% over the next 35 years and between 26% and 138% over the next decade. Conversely however, the renewable sub-sector could see average annual returns increase between 6% and 54% over the next 35 years or between 4% and 97% over 10 years.
Mercer Responsible Investment Team chairman Jane Ambachtsheer said: “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.”
Speaking at the report’s launch, Church Commissioners head of responsible investment Edward Mason called for a “culture shift” in asset management away from short-termism towards thinking like “future makers”.
He added: “Climate change is an investment risk and we have recognised this in our policy. It is so much better for investors to be future ‘makers’ rather than future ‘takers’. This is a major challenge that requires attention.”
Mason said the report would encourage the Church Commissioners to work with its outsourced developed market equity managers on environmental risk, adding the Church’s three National Investing Bodies have adopted a climate change policy which states they wants to be at the “forefront” of addressing the transition to a low carbon economy.
Environment Agency chief responsible investment and risk officer Faith Ward said the scheme exited its passive FTSE All Share allocation because of its intense carbon exposure. The fund has adopted a low carbon benchmark, but Ward said more could still be done.
She added: “You are going to have to differentiate global equity [exposure] unless you want to be hit pretty hard.”