Property, infrastructure and emerging market equities are likely to be boosted by a global focus on climate change mitigation, research conducted by Mercer and backed by the World Bank has concluded.
The in-depth report, also backed by government departments in the UK and Germany, examines four potential scenarios that include governments succeeding in limiting temperature increases to 2°C, a 3°C scenario and two where the average temperature is 4°C above the pre-industrial average.
The first two scenarios – labelled transformation and coordination – are likely to see “positive” additional returns for both infrastructure and emerging market (EM) equities, according to the report, ‘Investing in a time of climate change’.
It says further gains can also be expected from real estate, as the asset class benefits from changes in the technology sector.
However, the report also warns that agriculture and timber are the two real-asset sub-classes most likely to be affected, either positively or negatively, depending on which of the four scenarios occurs.
The report adds: “Developed-market sovereign bonds are not viewed as sensitive to climate risk at an aggregate level (they are driven by other macro-economic factors), with exceptions, such as Japan and New Zealand.”
The report says developed-market global equity is likely to be affected, irrespective of which of the four scenarios occurs, with the coal sector predicted to see average annual returns falling from of 6.6% to 5.4% over the next 35 years.
While the report warns that coal returns could fall as low as 1.7% per annum over the 35-year timeframe, other sources of energy – such as renewables – stand to benefit.
“Renewables have the greatest potential for additional returns,” it says.
“Depending on the scenario, average expected returns may increase from 6.6% p.a. to as high as 10.1% p.a.
“Oil and utilities could also be significantly negatively impacted over the next 35 years, with expected average returns potentially falling from 6.6% p.a. to 2.5% p.a. and 6.2% p.a. to 3.7% p.a., respectively.”
The Mercer report accepts that it could be difficult for investment committees to take on board individual or even sector-specific “winners and losers”, noting that it would require the committee to engage with asset managers directly.
It suggests that investors adopt low-carbon indices, or that “more sustainable” variations of the existing broad market indices be adopted for passive mandates “to provide investors with the means to hedge climate exposure”.
The consultancy said the recommendations within the report – supported by asset owners and managers worth $1.5trn (€1.3trn), including the UK’s Environment Agency Pension Fund and AP1 – would be re-examined in 2016, with partner investors seeing how the recommendations affected their portfolios.