February 17, 2011
Mercer Issues Report on Climate Change and Investment
by Robert Kropp
Warning that portfolio risk could increase by 10% in the next 20 years, Mercer recommends that at
least 40% of the portfolios of institutional investors include investments in climate change
mitigation and adaptation.
Asserting that "investors cannot simply rely on a best guess as to how the future will unfold when
planning their investments," Mercer has
published a report that states, "Institutional investors must develop new tools to more effectively
model systemic risks such as climate change."
Warning that the quantitative
analysis of traditional asset allocation fails to account for the potential impacts of climate
change, the report, entitled Climate
Change Scenarios – Implications for Strategic Asset Allocation, states, "Historic precedent is
not an effective indicator of future performance." According to the report, the economic cost of
climate policy could lead to as much as a 10% increase in portfolio risk in the next 20 years.
The report points out that at present, the short-term horizon of most equity and bond
investments prevents investors from factoring in the long-term risks and opportunities relating to
climate change. Furthermore, allocating assets to more conservative investment products is unlikely
to be helpful, and may in fact reduce returns on investment.
Instead, the report
continued, investors should assess qualitative inputs such as investment opportunities in low
carbon technologies, the effect on investment of changes to the physical environment, and the
effect of policy on the cost of carbon.
"Climate-related policy changes could increase the
cost of carbon emissions by as much as $8 trillion over the coming 20 years," Danyelle Guyatt, head
of global research for the Responsible Investment team at Mercer, said. "The longer the delay, and
the poorer the coordination in implementing the changes, the more uncertainty there will be for
investors. The cost of impacts to the physical environment could exceed $4 trillion."
findings had three broad objectives," Guyatt continued. "First and foremost, we wanted to
investigate and analyze in detail the potential investment risks resulting from climate change. We
also wanted to look at the key performance drivers for many of the leading markets and regions
around the world that our clients are invested in. And third, we wanted to identify the scenarios
around climate change that will help us better understand and frame climate change as a strategic
By "increasing investment in mitigation and adaptation efforts
globally," the report finds, institutional investors can both serve the financial interests of
beneficiaries and help address climate change. A typical portfolio seeking a seven percent return
on investment, for instance, "could manage the risk of climate change by ensuring around 40% of
assets are held in climate sensitive assets," according to the report.
climate-sensitive assets may, in some cases, be more risky as standalone investments, the report
continues, portfolio risk can actually be reduced by investment in assets directed toward
mitigation and adaptation.
The report recommends that investors consider rebalancing their
portfolios to include sustainable assets addressing infrastructure, private equity, real estate,
forestry and agriculture.
"Investment opportunities in low-carbon technologies could be as
high as $5 trillion by 2030," Guyatt said.
An effective way of managing portfolio risk at
present is passive investment in sustainable indexes, according to the report. Other steps that
institutional investors can take immediately include the introduction of climate risk assessment
into strategic reviews, as well as encouraging fund managers to proactively manage climate risks.
Investors should also act on their responsibilities of active ownership by engaging with
companies in their portfolios to encourage the incorporation of climate-related risks and
opportunities into business operations.
Perhaps of especial importance, according to the
report, is "the need for investors to communicate with policymakers the need for a clear, credible
and internationally coordinated policy response" to climate change.
articulated policies addressing climate change, the report warns, investment volatility will
increase, and many investors will delay investment in low-carbon technologies until such policies
are in place.
"While many institutional investors might view engagement with policymakers
as a separate function from strategic decision-making processes," the report states, "It can play a
vital role in overall portfolio risk management."
Guyatt said, "The report is about
setting the framework for how institutional investors can adapt to the transformation" to a
Responding to the report, Mindy Lubber, president of Ceres and director of the Investor Network on Climate Risk (INCR), said, "No prudent investor
can disregard a risk as great as 10 percent on portfolio performance, no matter how nontraditional
the source of that risk may be. At the same time, no prudent investor can ignore the potential for
low-carbon investment opportunities that could be as high as $5 trillion by 2030."
truly effective investment response," Lubber continued, "Policy makers and regulators must ensure
that investors have the information they need from companies to make prudent investment decisions.
Equally important, policymakers must enact carbon-reducing policies that investors need for
shifting large amounts of capital toward low-carbon technologies and away from higher-polluting