Climate change increasingly seen as material threat to asset funds

17 July 2018 5 min. read

Large numbers of people rely on their pensions for retirement, and while current pension funds total tens of trillions of dollars, concern around their sustainability is mounting. The material risks associated with climate change are increasingly being seen as a threat, while many others are set to diversify their holdings, particularly into bonds, as de-risking takes hold, according to a new report.

While the business world has finally begun to acknowledge the danger of climate change, what to do about it this far into the problem remains problematic. The Paris Agreement has stipulated a clear target for the decades leading up to 2100, although rebuffing vested interests and not crashing the economy is a difficult task.

One key group, which holds considerable economic clout, are pension funds. These funds, while required to generate a certain return on investment, total into the tens of trillions (the top 300 holding $41 trillion), which, when leveraged to take into account environmental concerns, are capable of generating considerable change, according to an investment profile of the world’s largest funds by Mercer’s ‘European Asset Allocation Survey 2018’ report.

Pension funds strategy and allocation by country

The report considers the current status of the funds, as well as various risks faced by fund managers in an increasingly uncertain global environment. The funds are broadly distributed, although different countries tend to have different investment strategies.

Belgium is the most equities heavy among countries surveyed, all of which are not invested in their domestic market, while Germany CTA’s 40% equity split is half domestic and half non-domestic in investment strategy. France meanwhile has a relatively small 33% of assets under management allocated to equities, of which the vast majority (87%) is in its domestic markets.

Pension plans planning strategy changes

On average bonds are preferred, totalling 52% of the strategic asset allocation, with Portugal, the Netherlands, Norway and Denmark being major contributors. Alternatives garner 27% of German investment and 26% of Danish allocation, while cash is relatively uncommon.

The study notes that strategic plans are set to shift away from domestic equities, with 23% citing a change in strategy away, compared to 1% that plan to increase allocation. Non-domestic equities see a net -8% change, while the allocation of domestic fixed interest government bonds is set to increase by a net 15% and  domestic inflation-linked government bonds will see a net 24% allocation change in strategy. Alternatives too are set to see decreased appetite, to a net -7%, while domestic corporate bonds see a slight increase to a net 6% change. The shift reflects recent strong gains in various markets, as well as a process of de-risking.

Delegation of De-risking

De-risking has become an integral part of the wider strategy of asset managers in the space, as global geopolitical shifts begin to take hold, while populations age. The bull run on equities is unlikely to last forever, as bond markets recover from long-term low-rates. The de-risking process is set to take around 15 years for 79% of total respondents. Delegation for the process is by-and-large in the hands of third parties (75%), followed by investment subcommittees (14%).

Responsible investment

Investors are increasingly aware of key ESG risks facing their wider portfolios, particularly related to the impact of such investments on social and environmental outcomes. One of the frameworks to integrate such concerns into investment practices is the ESG. As it stands, around 40% of respondents consider ESG risks as part of their investment activity.

The major driver for inclusion of ESG into the investment decision making process were regulatory drivers, including the guidance from the UK’s Pensions Regulator and EU Commission action plan on financing sustainable growth which focuses on, among others, reducing unaccounted for risks. The market is also becoming increasingly aware of the material risks associated with investments in unsustainable forms of production and consumption, which was cited by 25% of respondents. Individual actions at the trustee board level accounted for 18% of considerations of ESG risks, while alignment with sponsors' corporate responsibility strategy was cited by 11% of respondents.

Key drivers behind ESG risk considerations

The increasingly important shift in material risks associated with ESG risks is also seeing investment decision shifts at corporates related to climate change – 17% of respondents now cite it as an issue, up from 4% x years ago.  

The report concluded, “With regulatory guidance increasingly clarifying this consistency, we believe some of the former myths that have plagued the successful integration of ESG into mainstream investment processes over the last decade are closer to being dispelled. In time, we believe the opposite will become the standard market position – that is, not considering ESG risks will be seen as a breach of fiduciary duty.”

Related: The largest actuarial and pension consulting firms in the UK.