Regardless of whether one thinks the science of climate change is settled or not, the economic effects of particular scenarios cannot be ignored. Mercer takes a look at investor outcomes.

Climate change will create winners and losers in business, with average annual returns from the coal production sector plunging up to 74 per cent between now and 2050 while renewable energy returns could surge by more than half over the same period, depending on how dramatic any change proves to be, argue consultants at Mercer.

The firm seeks to model the potential investment effects of climate change and says investors cannot ignore these. The report, titled Investing in a time of climate change, outlines actions for investors to manage key downside risks and access opportunities. 

The report is the culmination of a research project that began in September last year and was launched yesterday ahead of talks for a new global climate agreement at the end of 2015 in Paris.

Among the statistical predictions given by the report is that average annual returns from the coal sub-sector could fall by anywhere between 18 per cent and 74 per cent over the next 35 years, with effects being more pronounced over the coming decade (eroding between 26 per cent and 138 per cent of average annual returns over the next 10 years). Conversely, the renewables sub-sector could see average annual returns increase by between 6 per cent and 54 per cent over a 35-year time horizon (or between 4 per cent and 97 per cent over a 10-year period) depending on the climate scenario. 

The investment modelling in Mercer’s report estimates the potential impact of climate change on returns for portfolios, asset classes and industry sectors between 2015 and 2050, based on four climate change scenarios and four climate risk factors. The four scenarios represent a rise in global temperature above pre-industrial era temperatures of 2°C, 3°C and two 4°C scenarios (with different levels of potential physical impacts).

The report is an example of how climate change, or man-made global warming as it is sometimes called, is seen as a major theme driving asset allocation and investment. Regardless of whether investors agree or not with the more gloomy predictions of climate change “alarmists”, the response by policymakers – taxes, rules banning certain forms of energy use, subsidies for solar power, etc – mean the issue can have a marked economic impact.

To produce the report, Mercer said it worked with 16 investment partners, collectively responsible for more than $1.5 trillion of assets. The work was supported by IFC, the private sector arm of the World Bank Group, in partnership with the Federal Ministry for Economic Cooperation and Development, Germany, and the UK Department for International Development. The study was also supported with contributions from Mercer’s sister companies NERA Economic Consulting and Guy Carpenter, and input from 13 advisory group members. 

Other findings
Among specific findings, Mercer said that a 2°C temperature rise scenario could see return benefits for emerging market equities, infrastructure, real estate, timber and agriculture. A 4°C scenario, however, could negatively impact emerging market equities, real estate, timber and agriculture.

“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,” Helga Birgden, partner and global leader of Mercer’s responsible investment business, said.

“This report can act as a guide to creating an action plan. Whether it is setting portfolio de-carbonisation targets, investing in solutions that address risks and opportunities, or increasing engagement with managers and companies, our report shows investors how they might take action. Engaging with policymakers is also crucial and helps empower investors in their role as ‘future makers’,” she said.