Funds using climate risks in asset decisions

SUPERANNUATION funds, including the $42 billion industry fund AustralianSuper, are beginning to factor climate risks into investment decisions, according to a report by actuarial firm Mercer.

By InvestSMART · 25 Jan 2012

By InvestSMART ·
25 Jan 2012

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SUPERANNUATION funds, including the $42 billion industry fund AustralianSuper, are beginning to factor climate risks into investment decisions, according to a report by actuarial firm Mercer.

The report surveyed 12 pension funds around the world, with a combined $US2 trillion ($1.9 trillion) in assets, to identify what follow-up actions they had taken since Mercer found last February that climate could account for 10 per cent of typical portfolio risk and that funds should invest 40 per cent of their portfolio into so-called "climate-sensitive assets".

Of the 12 funds, including AustralianSuper and VicSuper, Mercer found: more than half had decided to include climate change considerations in future risk management and/or strategic asset allocation processes half had changed or planned to change their asset allocations and 80 per cent had or would increase their engagement on climate change with companies and policy makers.

The chief investment officer of AustralianSuper, Mark Delaney, said his fund had not changed its strategic asset allocation and that climate risks need "to be dealt with within the asset class rather than between the asset classes".

But AustralianSuper had analysed the carbon exposure of its portfolio (except for bonds and cash) and engaged with fund managers responsible for security selection across shares, property and infrastructure.

Mr Delaney said AustralianSuper's analysis showed the impact of the carbon tax on the value of listed equities was small and it was too early to tell which of $5 billion in infrastructure assets would be hardest hit by increased risks of fire, flood and so on.

In property, Mr Delaney said the market had moved "well before the policy framework has changed" and the value of buildings was already shifting due to tenants' green preferences.

The Guardian reported last Thursday a high-profile coalition of investors, politicians and scientists wrote an open letter to the Bank of England governor Sir Mervyn King, warning that the huge reserves of coal, oil and gas held by stock exchange-listed companies were "sub-prime" assets that were potentially mispriced and posed a systemic risk to economic stability.

At December's United Nations climate change summit in Durban, 194 nations agreed to enact legally binding curbs on greenhouse gas emissions within three years to limit global warming to two degrees, they wrote, but meeting this limit would mean just 20 per cent of existing fossil fuel reserves could be burned. They urged Sir Mervyn, as chairman of the financial policy committee, to investigate the risk of a "carbon bubble".

Deutsche Bank analyst Tim Jordan said the market capitalisation of ASX 200 companies engaged predominantly in fossil fuel exploration and production was nearly $70 billion - and much more if BHP Billiton and Rio Tinto were included - but no analysis had been done in Australia of the market value of attributed fossil fuel reserves.

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Frequently Asked Questions about this Article…

What did Mercer’s report reveal about superannuation funds factoring climate risk into investment decisions?

Mercer surveyed 12 pension funds with about US$2 trillion (A$1.9 trillion) in assets and found climate could account for about 10% of a typical portfolio’s risk. The report recommended increasing exposure to “climate‑sensitive assets” (suggesting up to 40% of a portfolio) and found that more than half of the surveyed funds had added climate considerations to risk management or strategic asset allocation, about half had changed or planned to change asset allocations, and 80% had increased or planned to increase engagement with companies and policy makers on climate issues.

Has AustralianSuper changed its strategic asset allocation because of climate risks?

No — AustralianSuper’s chief investment officer Mark Delaney said the fund had not changed its strategic asset allocation. Instead, AustralianSuper prefers to address climate risks within each asset class (shares, property, infrastructure) and has analysed the carbon exposure of its portfolio (excluding bonds and cash) and engaged with the fund managers responsible for security selection.

How are funds measuring and acting on carbon exposure in their portfolios?

According to the article, funds are analysing carbon exposure across equity, property and infrastructure holdings (AustralianSuper did this for all but bonds and cash) and are engaging with fund managers and companies. More broadly, Mercer’s survey showed many funds are integrating climate change into future risk management and strategic allocation processes and increasing engagement with companies and policymakers.

Will a carbon tax or climate policy hit listed equities and infrastructure hard?

AustralianSuper’s analysis found the impact of a carbon tax on the value of listed equities was small at the time of the report. However, Mark Delaney said it was too early to say which parts of about $5 billion in infrastructure assets would be most affected by climate‑related physical risks such as fire or flood.

How is the commercial property market responding to climate and green preferences?

The article notes the property market has already begun adjusting ahead of policy changes: building values are shifting as tenants show greener preferences, and market pricing appears to be moving in response to those tenant demands.

What is the ‘carbon bubble’ and why are investors and policymakers concerned?

A high‑profile coalition told the Bank of England that large reserves of coal, oil and gas held by listed companies may be “sub‑prime” or mispriced, posing a systemic risk. They pointed to the UN Durban outcome — commitments to legally binding greenhouse gas curbs to limit warming to 2°C — noting that meeting those goals could mean only about 20% of existing fossil fuel reserves are burnable, which raises concerns about overvalued fossil fuel assets or a ‘carbon bubble.’

How large is the market value of fossil‑fuel companies on the ASX and has Australia measured reserve valuation risk?

Deutsche Bank analyst Tim Jordan estimated the market capitalisation of ASX 200 companies mainly involved in fossil fuel exploration and production was nearly A$70 billion, and that figure would be much larger if major miners like BHP Billiton and Rio Tinto were included. The article says no comprehensive analysis had been done in Australia on the market value of attributed fossil fuel reserves.

What practical steps should everyday investors watch for as funds respond to climate risk?

Based on the report and fund actions described, everyday investors should watch whether their superannuation or managed funds: (1) disclose carbon exposure and climate risk analysis; (2) integrate climate into risk management and strategic asset allocation; (3) increase engagement with companies and policymakers on climate; and (4) adjust holdings in property, infrastructure or equities as market pricing and tenant preferences change. These are the kinds of moves funds in the Mercer survey were already making.