Advisers might want to begin talking to their clients about the investment risk of climate change before the international conference on climate in Paris in December starts generating headlines.
Large institutional investors overwhelmingly incorporate climate change risk assessments into their investment analysis and stock selection process. So it may only be a matter of time before retail investors start to wonder if their portfolios are structured to take advantage of the investments that stand to gain from climate changes and protected from those that are likely to be hurt?
Some financial advisers incorporate investment filters that screen out companies with the highest carbon footprints, and an increasing number of mutual funds are focused on fossil-fuel-free investments. Even exchange-traded funds are looking to help investors find the upside of climate change risk by investing in clean energy technologies.
“We are at an inflection point. Going forward, high-carbon fuel sources are a bad investment, like getting behind the horse and buggy in the 1920s,” said Marlena Sonn, founder of Treebeard Financial Planning. “The switch to solar and wind will happen faster and more dramatically than oil and gas companies are expecting.”
A new report by international consulting firm Mercer, “Investing in the Time of Climate Change,” analyzes the impact climate change could have on investments over the next 35 years, and it considers four different warming scenarios.
It concludes that a two to four-degree Celsius change will cause the coal sector to fall between 18% and 74% through 2050, “with effects more pronounced over the coming decade,” when 26% to 138% of average annual returns would be eroded, the report authors said.
The renewables sector would see average annual returns rise between 6% and 54% over the next 35 years, the report concluded.
The impact on asset-class returns varies more based on the different scenarios, with growth assets being more sensitive to climate risk than defensive assets, according to the analysis, which Mercer wrote in collaboration with 16 investment partners representing $1.5 trillion in assets.
One of those partners was State Super Financial Services, an Australian firm that provides financial planning to public sector employees.
“Climate change forces investors in the 21st century to reconsider our understanding of economic and investment risk,” said Damian Graham, chief investment officer of the firm.
Ms. Sonn said she believes regulatory environments will become stricter in the years following the new global climate agreement set to be finalized in December at the United Nations Framework Convention on Climate Change conference, dubbed COP 21.
Patricia Farrar-Rivas, chief executive of advisory firm Veris Wealth Partners, said she approaches climate change investment risk by talking with clients about different sectors where the impact will be greatest, beginning with energy.
She describes the “stranded assets” of large fossil-fuel producers, showing clients how these firms are overvalued if their reserves will not be usable under future government curbs on emissions.
On the other hand, alternative energies are projected to form 60% of the energy supply mix by 2040, she said.
“Over the long term, these portfolios will perform better because you will be investing in companies that will be leaders in the tomorrow’s economy,” she said.
In addition to the 100-page Mercer report, USSIF has a climate change guide for investors and the Investor Responsibility Research Center Institute has analyzed the global carbon exposure of companies in the S&P 500.