Limiting global warming is essential to institutional investors, according to a new report by Mercer Canada.
The report models three different scenarios, examining the impact of average warming of two, three and four degrees Celsius over three timeframes: 2030, 2050 and 2100. For both investors and the planet, limiting warming to two degrees is ideal, it said.
“A below two degree scenario is most beneficial and the four and three degree scenarios are to be avoided, from a long-term investor perspective,” noted the report.
Indeed, if warming can be limited to two degrees, the required transition to a low-carbon economy is now “expected to be a benefit from a macroeconomic perspective,” the report said.
While this scenario would still pose a transition risk, there are opportunities for investors to target mitigation and adaptation solutions the transition will require, the research found.
Yet, in scenarios where warming is allowed to go beyond that limit, the report saw permanent physical damage — such as the complete loss of Arctic sea ice — that would produce large rises in sea levels, intensifying heat waves, forest fires, drought and famine.
“Humans have never lived in a world much warmer than today; yet, the current trajectory of at least three degrees above the pre-industrial average by 2100 could put us beyond the realm of human experience sometime in the next 30 years,” the report said.
“A key conclusion is that investing for a two degree scenario is both an imperative and an opportunity,” said Helga Birgden, global business leader of responsible investment, at Mercer. “It’s an imperative, since for nearly all asset classes, regions and timeframes, a two degree scenario leads to enhanced projected returns versus three or four degrees and therefore a better outcome for investors,” she said. “It’s an opportunity, since although incumbent industries can suffer losses in a two degree scenario, there are many notable investment opportunities enabled in a low-carbon transition.”
For investors, the expected impact on annual returns would be most visible at an industry-sector level, the report said, “with significant variations by scenario, particularly for energy, utilities, consumer staples and telecoms.”
Further, the report noted asset class returns can also vary quite significantly depending on which climate change scenario manifests, with infrastructure, property and equities being the most notable.
Changes in return impacts are likely to be sudden, rather than smooth, the report also found. As a result, it said it’s important for investors to stress test their portfolios.
“Stress testing portfolios for changes in view on scenario probability, market awareness and physical damages can help investors consider how longer-term return impacts that may appear small on an annual basis could emerge as more meaningful, shorter-term market repricing events,” it said.
Indeed, the report argued institutional investors have a fiduciary duty to assess the impact of climate change on their portfolios.
“With recent research showing Canada is warming at twice the rate of the rest of the world, climate-aware investing is critical for every institution in this country — and that includes institutional investors like pension funds,” said Karen Lockridge, principal, responsible investment, for Mercer Canada.
“A pension fund needs to have a long-term view, and in the modern world that means ensuring your asset allocation is future-proofed against the risks and uncertainties posed by a warming climate,” she added.
This article originally appeared on Benefits Canada‘s companion site, Advisor.ca