Climate change increasingly seen as material threat to asset funds

17 July 2018

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.


WEF finds no progress made on greening economy

01 April 2019

The reports of two influential bodies, in the space of a day, have warned that no progress is being made to prevent major climate change. The World Economic Forum has warned that greening of the global energy transition has stagnated over last five years, while the International Energy Agency has confirmed coal use rose again last year.

The position of the Academies of Science from 80 countries, plus a majority of scientific organisations that study climate science, is that humans are causing rapid climate change – often referred to as global warming. Roughly 95% of active climate researchers publishing climate papers endorse the consensus position that since the industrial revolution, the boom in carbon emissions from fossil fuel powered human activity has heavily impacted the planet, with rising levels of CO2 and other greenhouse gases trapping heat from the sun causing global temperatures to rise – something which will have catastrophic results in the near future.

Despite the steadfast consensus among the scientific community on the matter, however, there has been little to no meaningful action to avert disaster. In fact, while the signing of the Paris Accord was met with great excitement, since it came into force, global carbon dioxide emissions have continued to rise. Today, they sit at their highest levels yet, after a strong economy and extreme weather stoked a surge in energy demand last year.WEF finds no progress made on greening economyAccording to the world’s energy watchdog, the Paris-based International Energy Agency (IEA), energy spiked by 2.3% in 2018 – the biggest leap since 2010 – with that demand largely being met with fossil fuels. As a result, global emissions of carbon dioxide hit the record high of 33 billion tonnes in 2018, a rise of 1.7% on 2017’s figures. Commenting on the findings, IEA chief Fatih Birol said the rise in energy demand was “exceptional” and a “surprise for many.”

Birol added, “We have seen an extraordinary increase in global energy demand in 2018, growing at its fastest pace this decade. Looking at the global economy in 2019, it will be rather a surprise to see the same level of growth as 2018.”

The suggestion from Birol that 2018 is likely to be an anomaly which will not be seen again is strange, considering the added strain which the boom in emissions will place on the environment. To suggest that heightened energy demand was driven by extreme weather – which is increasingly difficult to claim is unrelated to man-made climate change – and then to suggest that such a thing is unlikely to occur any time soon in spite of emissions having increased seems contradictory.

Regardless of this, the bad news was further compounded within hours of the IEA’s release. A report from the World Economic Forum released on the same day concluded that the world's energy systems have not become any greener in the last five years. Despite the agreement of global climate targets, falling green power costs, and mounting public and business concern over the catastrophic impacts runaway climate change could wreak, the WEF’s damning assessment warned that little to no progress has been made on making energy systems more environmentally sustainable since 2014.

Coal is the largest hindrance of change on this front, according to the report. Recent years have seen improvements in energy access and security, but far too many nations remain dependent on coal power for the new energy systems to have made any environmental gains. At the same time, major economies have failed to decrease or even slow the amount of energy they use per unit of GDP, leaving smaller actors who have made changes micturating into a gale. Change on the part of the world’s largest economies is therefore crucial to driving the development of a greener, more efficient global economy, the WEF concluded.

Commenting on the findings, Roberto Bocca, leader of the WEF's future of energy and materials division, said urgent action is now needed to move toward decarbonisation. He added, "We need a future where energy is affordable, sustainable and accessible to all. Solid progress in bringing energy within the reach of more and more people is not enough to mask wider failures, which are already having an impact on our climate and on our societies."

The news comes even as sustainability continues to be talked about as a ‘top agenda item’ at the majority of the world’s largest corporations. While 85% say that it will be more important still in another five years, it is clear that the majority of the world’s most powerful businesses are failing to walk the talk on the matter, regardless of what governments do.