GLOBAL - Institutional investors need to take a threefold approach to integrate climate change in their asset allocation, according to Mercer's 'Climate Change Scenarios - Implications for Strategic Asset Allocation' report.

First, they need to enhance their approach to asset allocation - by creating a risk factor analysis, for example - but essentially discussing climate change both at the investment and the specialist level so trustees and investment committees are on top of the risk.

Second, as much as 40% of assets should be invested in climate-sensitive assets, such as infrastructure, real estate, private equity, timberland, agricultural land, green bonds and other listed or unlisted assets.

Speaking at the launch of the report, Danyelle Guyatt, global head of responsible investment research at Mercer, said: "Allocations to climate-sensitive assets have shown they can offer a good buffer for different climate policy scenarios.

"Some of these climate-sensitive investments might be traditionally deemed as more risky on a standalone basis, but the report shows selected investments in climate-sensitive assets with an emphasis on those that can adapt to a low-carbon environment could actually reduce portfolio risk in some scenarios."

Third, investors should engage with policymakers because the policy factor presents a significant source of risk.

Various pension funds have already tried to integrate the climate change risk into their portfolios.

Howard Pearce, head of environmental finance and pension fund management at the UK Environment Agency Pension Fund, said: "Climate change is an important fiduciary duty. It is a risk and an opportunity. We have had an environmental overlay for some time, which has included an element of climate change, but when we take up our new strategy in the next few years, this will be integrated even better."

Around 2% of the pension fund's capital used to be invested in alpha-seeking green assets. Now this number stands at 13%. By 2015, around 25% of the fund is expected to be positively invested to benefit a greener economy.

The UK's BT Pension Scheme, as part of the integration of climate change risk into its portfolio, has begun to de-risk and move away from equity and into alternatives, especially infrastructure.

Commenting on the study, Mindy Lubber, president of sustainability network and director of the Investor Network on Climate Risk, said: "Climate change poses real costs and risks that are material to investment portfolios of pension funds and institutions around the world.

"No prudent investor can disregard a risk as great as 10% on portfolio performance, no matter how non-traditional 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 $5trn (€3.7trn) by 2030."

Meanwhile, the Asset Owners Disclosure Project (AODP) has urged all large asset owners to disclose immediately how they plan to implement the recommendations of the Mercer report by responding to its climate disclosure framework.

AODP executive director Julian Poulter said: "The Mercer report shows how critical it is for funds to provide transparency on their exposures to climate risks and how they intend to hedge those exposures so members and stakeholders can judge their likely future performance.

"Funds can no longer rely on being tied to short-term markets to manage climate risk, and it seems they now have little choice but to radically restructure their portfolios and hedge against the inevitable impacts."