Op dinsdag 17 mei 2011 vond het seminar 'Scenario's voor klimaatverandering - implicaties voor strategische asset allocatie' plaats in het Drijvend Paviljoen in Rotterdam. Deze dag stond in het teken van de invloed van klimaatverandering op beleggingen van pensioenfondsen. Jelle Beenen was de dagvoorzitter en gaf tevens samen met Will Oulton (UK office) een presentatie over het rapport 'Scenario's voor klimaatverandering' dat onlangs is verschenen.

1. 17 May, 2011
The Impact of Climate
Change on Asset Allocation
Jelle Beenen
Will Oulton

2. Integrating systemic risks into strategic decision
making
What did we learn from the global financial crisis?
More ‘what if’ critical thinking is required
Need to think long-term and strategically
Risk is more than historical volatility and correlations
Source of risk beyond mean-variance analysis
Behavioural biases predominate (aka technology
bubble, corporate governance failures, the financial
crisis…climate change?)
We overlook systemic risks
Climate change is one of these risks
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3. Overview of the project:
Examine the implications of climate change for asset allocation
Collaborative effort led by Mercer together with
14 Asset owner partners
2 Industry sponsors
– IFC and Carbon Trust
1 Climate change research partner
– Experts were engaged from Grantham Research
Institute at LSE, chaired by Nicholas Stern (author of
Stern Review), together with Vivid Economics
9 Research group members
– Industry experts were consulted on the methodology
and research conclusions
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4. What determines long term investment performance
Determinants of Long-term Investment Performance
Asset Allocation,
91.5%
Security Selection,
4.6%
Asset Class Timing,
1.8%
Unexplained, 2.1%
Source: Brinson, Singer & Beebower, “Determinants of Portfolio
Performance II”, Financial Analysts Journal, May/June 1991
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5. How are long term decisions made?
Asset Class Return Risk Correlation
Index-Linked Gilts (20-year duration) 4.46% 8.69% 1.00
Fixed Interest Gilts (20-year duration) 4.46% 7.87% 0.66 1.00
AA Index-Linked Bonds (20-year duration) 5.78% 11.89% 0.73 0.40 1.00
AA Fixed Interest Bonds (20-year duration) 5.78% 11.30% 0.62 0.91 0.65 1.00
Absolute Return Active Strategy 4.46% 1.58% 0.09 0.03 0.02 0.03 1.00
ILGs (>5s) 4.46% 6.32% 0.96 0.70 0.67 0.64 0.14 1.00
FIGs (all) 4.46% 4.26% 0.72 0.88 0.42 0.78 0.24 0.78 1.00
FIGs (>15) 4.46% 6.05% 0.73 0.96 0.43 0.87 0.13 0.77 0.97 1.00
UK £ Credit(all) 5.78% 4.61% 0.60 0.75 0.54 0.80 0.28 0.62 0.83 0.81 1.00
UK £ Credit(>10) 5.78% 6.80% 0.68 0.91 0.61 0.95 0.14 0.72 0.90 0.93 0.88 1.00
Conventional Property 6.46% 14.87% 0.06 0.20 0.13 0.25 -0.20 0.04 -0.04 0.09 -0.00 0.10 1.00
HLV Property 5.46% 9.15% 0.18 0.31 0.17 0.33 -0.14 0.16 0.11 0.23 0.11 0.21 0.98 1.00
Hedge Funds 4.46% 1.58% 0.09 0.03 0.02 0.03 1.00 0.14 0.24 0.13 0.28 0.14 -0.20 -0.14 1.00
Commodities 4.46% 22.13% -0.16 -0.29 -0.21 -0.32 0.10 -0.17 -0.21 -0.27 -0.15 -0.29 -0.17 -0.21 0.10 1.00
Infrastructure (Debt) 5.14% 7.33% 0.87 0.53 0.91 0.66 0.08 0.87 0.63 0.61 0.62 0.69 0.05 0.13 0.08 -0.17 1.00
Infrastructure (Listed Equity) 8.14% 18.31% 0.31 0.25 0.51 0.45 0.05 0.30 0.18 0.21 0.26 0.35 0.18 0.12 0.05 -0.01 0.45 1.00
Infrastructure (Unlisted Equity) 10.52% 30.17% 0.20 0.11 0.45 0.32 0.01 0.18 0.02 0.06 0.13 0.21 0.19 0.10 0.01 0.02 0.35 0.99 1.00
Private Equity 11.39% 34.47% 0.17 0.08 0.43 0.30 0.00 0.15 -0.02 0.03 0.11 0.18 0.19 0.10 0.00 0.03 0.34 0.98 1.00 1.00
Equities 8.79% 16.57% 0.28 0.21 0.49 0.42 0.05 0.27 0.14 0.18 0.24 0.32 0.18 0.12 0.05 -0.00 0.43 1.00 0.99 0.99 1.00
Equities (Currency Hedged) 8.73% 15.94% 0.29 0.25 0.50 0.45 0.06 0.28 0.15 0.20 0.24 0.35 0.22 0.15 0.06 -0.07 0.43 0.98 0.97 0.97 0.98 1.00
Can this be all there is to it??
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6. Value at Risk, confidence interval. But where is the risk?
Where should the focus be, on the red or on the green?
95%
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7. Scenario Analysis
Growth Inflation Temperature
Equities
Equities IL Bonds
IL Bonds
Credit
Credit Insurance
Insurance
Commodities
Commodities Commodities
Commodities
Rising ?
Real Assets
Real Assets Real Assets
Real Assets
Credit
Credit Equities
Equities
Bonds
Bonds Credit
Insurance
Insurance
Credit
Bonds
Bonds
Falling ?
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8. Little consideration has been given to
understanding what climate change
means for long term risks and
opportunities as part of strategic asset
allocation decision making…
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9. The participants
Norwegian
Government
Pension Fund
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10. A natural evolution: climate scenarios for capital markets
The United Nations Intergovernmental The Stern Review on the Economics of Climate Change Scenarios – Implications
Panel on Climate Change Climate Change for Strategic Asset Allocation
(1990-2014) (2006) (2011)
Six ‘emissions marker scenarios’ Two climate change scenarios Four scenarios (including one based
(baseline based on IPCC ‘A2’) on Stern)
Assesses scientific, technical and
socio-economic information Examines the evidence on the Attempts to build on prior studies to
concerning climate change, its economic impacts of climate change explore the impact of climate scenarios
potential effects, and options for itself, and explores the economics of on markets through asset class and
adaptation and mitigation stabilizing greenhouse gases in the regional analysis
atmosphere
Involves thousands of authors from Undertaken by Mercer, climate change
dozens of countries Advocates as urgent priorities for experts and some of the world’s largest
international cooperation: broadly asset owners
similar global carbon price signals and
using carbon finance to accelerate
action in developing countries
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11. The benefits of scenario analysis for SAA
Not everything can be quantified
Tail risks - think the unthinkable
Be aware of risks and opportunities that might not
otherwise have been considered
Scenario planning to improve decision-making
Signposts to prepare minds for explicit indicators of the
future
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12. Climate Change Study
The 4 scenarios

13. The 4 Scenarios
Regional Divergence Delayed Action
Uneven progress on ‘Business as usual’ until
cutting emissions, with 2020
strong leadership in
Bad news about rapid
some regions and
climate change triggers a
others lagging behind
global policy ‘shock’,
Currently most likely rapidly driving up the cost
scenario of fossil fuels
Cost of carbon Cost of carbon $15/tCO2e
$110/tCO2e globally to 2020, then dramatic rise
to $220/tCO2e
50 Gt CO2e emissions
per year in 2030 50 Gt CO2e emissions per
year in 2030
Comprehensive global Continued reliance on
framework to cut fossil fuels and high
emissions quickly and emissions of carbon
deeply
Little transformation to a
Market anticipates the low carbon economy,
policy measures, smooth increases physical
adjustment ‘impact’ risks
Cost of carbon Cost of carbon $15/tCO2e
$110/tCO2e globally limited to EU ETS
30 Gt CO2e emissions 63 Gt CO2e emissions per
per year in 2030 year in 2030
Stern Action Climate Breakdown
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14. Why scenario analysis?
Every link in the chain from carbon emissions to their impacts is uncertain
– Including efforts to cut emissions and adapt to climate change (driven
in part by government policy)
These uncertainties are new; historical records don’t really include them
The uncertainties are ‘deep’, meaning probabilities cannot be assigned
with confidence
Ideally suited to exploring extreme events and searching for ‘black swans’
– “the methodical thinking of the unthinkable”
Identifies storylines or sequences of events, and their consequences
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15. Scenarios compared: carbon emissions
Sources: Vivid Economics and Grantham Research Institute, based on Bowen and Ranger (2009),
IEA (2007; 2009) and Enkvist, Naucler et al. 2007
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16. Mercer TIP Model - Technology, Impacts and Policy
(“TIP”) risk factors
These factors estimate the potential impact of climate change on the
return drivers of different asset classes, where:
Technology (T) measures the rate of progress and investment
flows into technology related to low carbon and efficiency which
are expected to provide investment gains
Impacts (I) measures the extent to which changes to the physical
environment will impact (negatively) on investments
Policy (P) – measures the cost of policy in terms of the change in
the cost of carbon and emissions levels that result from policy
depending on the extent to which it is coordinated, transparent and
timely
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17. Climate sensitive assets to the TIP risk factors
Not only ‘sustainable assets’ but core assets also highly sensitive to climate
change. The following lists the assets whose underlying risk/return
characteristics are the most sensitive to the TIP risk factors:
– Infrastructure
– Private equity
– (Some) emerging market investments
– Real estate
– Agricultural land
– Timberland
– Sustainable equity (broad and sector theme)
– Efficiency/renewables (listed and unlisted)
– Further development of green bond market
– Maturing and expansion of carbon market
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18. Climate Change Study
Key findings

19. Message 1: Climate change increases uncertainty for
investors
Finding
Climate change increases uncertainty for institutional investors and
can potentially have a significant impact on the performance of a
portfolio mix over the long-term
Action
Embed an early warning system. Prudent risk management
processes should build in climate change considerations into long-term
strategic decision making processes, to help manage the uncertainties
associated with climate change
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20. Message 2: A factor risk approach that includes climate
change factors presents a solution
Finding
Scenario analysis and a factor risk framework are helpful in considering how
climate change might impact a portfolio
To address this, we developed the “TIP” framework to examine risks more
closely defined as:
the rate of progress and investment flows into technology (T)
the extent to which changes to the physical environment will impact on
investments (I)
the degree to which climate policy is coordinated, transparent and
timely (P) to help mobilise behaviour change
Action
Utilise scenario analysis and factor risk framework to review asset
class sensitivities to climate change
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21. Message 3: Equity Risk Premium and uncertainty are
key drivers for evaluating asset class impacts
Finding: Our study concluded that the equity risk premium differential
could be as great as 2% between a smooth mitigation scenario and a
delayed action scenario over the next 20 years.
– Knowing what risks to focus on will be key. Only one of the
scenarios had a notable impact on inflation and interest rates
(Delayed Action).
– Of more importance for investment decisions out to 2030 will be the
additional uncertainty that climate change produces and how
sensitive different asset classes are to these uncertainties.
Action: Review baseline assumptions regarding ERP and
uncertainties around the baseline risk/return data across asset classes
in light of the findings of this study. Seek innovative ways to capture
uncertainties around climate change
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22. Message 4: Technology, Impacts and Policy are
additional sources of risk for asset classes
Finding: Traditional factor risks are an important consideration but in
isolation are not sufficient to measure the investment uncertainties due
to climate change.
– A climate change investment risk framework was developed to
examine this more closely. This was specified as a ‘TIP’ framework,
defined as:
the rate of progress and investment flows into technology (T)
the extent to which changes to the physical environment will
impact on investments (I); and
the degree to which climate policy is coordinated, transparent
and timely (P) to help mobilise behaviour change
Action: Review asset class sensitivities to climate change in light of
the findings of this report and consider possible impact on risk/return
assumptions to incorporate climate change risks.
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23. Message 5: TIP climate risk factors are potentially
significant
Finding: Measuring the magnitude of the TIP factors reveals a potentially
large mobilisation of capital and associated costs that is significant for
investors. For example:
– The cumulative value of the Technology factor to 2030 (for the mitigation
scenarios) ranges between 9-13% of the value of global market
capitalisation and 12-17% of the value of global institutional assets under
management.
– The cumulative value of the Impact costs to 2030 represent some 3-9% of
global market cap and 5-12% of global AUM
– The cumulative value of the Policy costs to 2030 falls in a similar range at
4-12% of global market cap and 6-16% of global AUM. Put another way,
policy costs will be between 3x and 9x higher than they are today for all
mitigation scenarios
Action: You could start by embedding TIP factors into regular strategic
discussions and review processes to ensure that the risks are being
appropriately managed
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24. Message 6: Long horizon and real assets most sensitive
to climate change
Finding: For the mitigation scenarios, we concluded that infrastructure, private
equity, real estate and some commodities (timber, agriculture and carbon) are
more sensitive to climate change, both in terms of the risk and opportunities.
– Under the more efficient mitigation policy scenario, such as Stern Action,
some of these assets will be better suited to manage the risks and capture
the upside than equities and bonds.
– For scenarios where policy is more uncertain and difficult to predict, such
as Delayed Action, sustainability themed equities, renewable energy, green
bonds and some commodities will be more resilient.
Action: Go long and get ‘real’. Review asset mix in light of these findings,
including allocation to long horizon and real assets, as well as ‘sustainability’
themed investments across different asset classes
– Engage with active managers and look for new passive options
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25. Message 7: Regions that lead climate transformation
more resilient and appealing for long term investors
Finding: The regions that are best placed to attract capital from long-term
institutional investors will be those that take the lead in finding alternative
sources of energy, improving efficiency, reducing carbon emissions and
investing in new technology.
– Based on the regions examined in this study, indicators of future
investment flows out to 2030 suggest that the greatest upside potential
could be in the EU and China.
– This should be interpreted with caution as generalised conclusions are
difficult to make as the impact will vary significantly by type of asset, as
some regions have more supportive policies in place for renewable energy
or focus more on building efficiency, for example.
Action: Evolve and transform. Consider implications for assets where regional
allocation is possible to nuance, such as equities, private equity, infrastructure
and property
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26. Peer comparison – TIP contribution
Regional divergence and Delayed action scenarios
Peer comparison of TIP contribution to portfolio risk for each scenario
40% 40%
35% 35%
30% 30%
25% 25%
20% 20%
15% 15%
10% 10%
5% 5%
0% 0%
Technology Impact Policy Technology Impact Policy Technology Impact Policy Technology Impact Policy
Regional Divergence Delayed Action Regional Divergence Delayed Action
Fourth Quartile Third Quartile Second Quartile First Quartile
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27. Asset class sensitivity to TIP factors
Listed Equities Fixed Income Commod RE Private Equity Infra
Efficiency/renewables
Efficiency/renewables
Efficiency/renewables
Sustainable equity
Agricultural Land
Inv grade credit
Core, unlisted
Global equity
Global fixed
Timberland
Unlisted
EMD
EME
LBO
VC
Sensitivity L M H VH L M L H H H M H VH H VH
Regional Divergence
Delayed Action
Stern Action
Climate Breakdown
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28. Real Estate sensitivity to climate change factor risks
Climate Change Risk Factors Real estate Core Unlisted
Technology High
Impacts Low to Moderate
Policy High
Overall climate change sensitivity High
Observations:
– Technology: The largest carbon saving potential over the next few decades is
actually from retro-fitting rather than new build (in particular installing better
insulation to reduce heating and cooling needs).
– Impacts: The main changes anticipated are in demand for heating and cooling
as well as protection against intense precipitation and flooding (both coastal
storm surges and fluvial). Little variation is expected given that the impacts tend
to occur outside of the 2050 timeframe.
– Policy: An estimate from McKinsey shows emissions abatement potential in the
building sector of 28% reduction in greenhouse gas emissions per year by 2030.
Furthermore, the IPCC report that net cost additions to achieve stabilised CO2
levels by 2050 will be 7% of total building costs worldwide.
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29. Opportunities in Infrastructure & Real Estate
The long horizon and the “real” nature of infrastructure and real estate
investments, increase the importance of climate-change risk factors
Infrastructure:
– Explore opportunities in energy, transport and water/waste, such as
decentralized electricity & heat generation, additional fuel capacity
storage; electrification of rail, electric cars and battery charging
replacement points, underground reservoirs, and desalination plants
Real Estate:
– Focus should be on unlisted (direct) core assets. Due to the long lives
of buildings and the large global stock of inefficient buildings, the
largest carbon-saving potential over the next few decades will be from
retrofitting (in particular installing better insulation to reduce heating
and cooling needs), not from new buildings
– Opportunities in energy & water efficiency management, heat pumps,
and solar space & water heating in buildings
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30. In conclusion: Three key actions for investors
Action 1: Enhance approach to asset allocation
A factor risk framework can be applied – TIPTM – to enable
measurement and management of Technology, Impact and Policy
risks and opportunities at the portfolio level.
Action 2: Allocate to climate sensitive assets
Investments that will adapt to a low carbon environment within
infrastructure, private equity, real estate, agriculture land, timberland and
‘sustainable’ themed assets will provide a hedge to climate risk.
Action 3: Engage with policy makers
The “P” factor contributes 10% of risk to a hypothetical portfolio. Investors
are increasingly engaging with policy makers to proactively manage this
risk.
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31. Policy
Climate policy risk is a notable source of risk for investors
The longer the delay – the higher the potential impact costs for investors
Investors should engage with policy makers on specific policy plans and
specific details of proposed policy plans
Collaborative engagement can be effective for institutional investors
Policy Makers should therefore recognise that:
– Policy is crucial for encouraging the mobilisation of capital
– Policy should be clear, consistent, co-ordinated and long term. Policy
uncertainty increases volatility and higher risk premium’s
– Delay now will cost later. Unforeseen and dramatic policy intervention
will have negative consequences on core assets of global portfolios.
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32. Making portfolios more resilient to climate change
Identify climate risk reduction / new opportunities
investments
(1) Long term Strategic (2) Evaluation of climate
Asset Allocation Mix risks and new opportunities
(4) Allocation to climate
basket of investments (3) Assessment of existing
exposure versus more
resilient exposure
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