Amid all the excitement leading up to Pope Francis’s recent encyclical, those following the debate around climate change might be excused for overlooking a report from the world of Mammon.

Investing in a time of climate change, from Mercer, a global firm of investment consultants, may not carry the moral weight of the Pope’s encyclical Laudato Si’. But, among managers of trillions of dollars of investment assets around the world, it may yet have more significant effects.

Investment consultants such as Mercer advise the world’s institutional investors on where to invest and what to invest in, which risks to worry about, and how they might best manage them. They are the gatekeepers that stand between those charged with stewarding the world’s pension funds and insurance company assets, and those seeking their investment.

This report from Mercer report is the latest example of a growing body of in-depth research and advice from investment consultants about the issue of climate change, and it is worth examining in some detail.

Its findings reinforce what many investors already know: climate change will affect investment returns, and how policymakers respond to rising emissions will dictate exactly how those returns are impacted.

But what is noteworthy about this piece of work is that it represents a step-change in the depth of research and detail of the advice that consultants are offering. Mercer’s first major paper on climate change, in 2011, took a high-level look at the issue, from the perspective of strategic asset allocation. Inevitably, such a perspective was “big picture”, offering relatively little actionable advice for large investors.

Mercer explicitly notes that itsnew report will allow investors to “increase the sophistication” with which they consider the effects of climate change policies and physical impacts on their portfolios.

Mercer is offering detailed analysis as to how four potential outcomes – ranging from a ‘transformation scenario’ that sees strong climate mitigation to a disastrous ‘fragmentation (higher damages)’ alternative – will affect individual industrial sectors. It notes that the effects of climate change will be “most meaningful” at the industry-sector level.

So, for example, it quantifies the likely impacts on the coal sub-sector, suggesting that the average annual returns from the coal sub-sector could fall by anywhere between 18% and 74% over the next 35 years. The renewables sub-sector, in contrast, could see average annual returns increase by between 6% and 54% over the same period.

But it also notes that industry sectors that are particularly sensitive to climate risks – such as energy, utilities and materials – will require detailed attention, attention that is likely to be beyond the remit of investment committees. This may require investors to allocate to different managers, and assess performance against new benchmarks.

We would argue that this vindicates the approach we have taken to investing. The effects of climate change policy and physical climate impacts – both negative and positive – will be highly differentiated between sectors and within them. While the energy sector may see the most pronounced effects, other sectors – from agriculture to pharmaceuticals – will all see profound impacts.

Investors need to develop, or access, in-depth understanding of how these effects will translate into shareholder value – and ensure that they are not carrying uncompensated climate risk within their portfolios.

The Mercer report concludes with an observation that, when it comes to climate change, all investors are ‘future takers’ – they will all feel the effects on returns of whichever climate change scenario comes to pass.

Impax is firmly in the emerging group of investors that Mercer defines as ‘future makers’ – those that feel compelled by the magnitude of the climate change challenge to try and influence which scenario transpires. Acknowledging the scientific consensus on climate change, and recognizing the threat it poses to long-term investment returns, these investors will both invest in line with the science, and encourage policymakers and businesses to take appropriate action.

Over the coming years, as the battle against climate change intensifies, it is likely that the ultimate beneficiaries of the world’s pension funds and insurance companies will increasingly want to know whether their prosperity is in the hands of future takers, or future makers. 

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