dollar boat in the bad weather illustration economic instability

Limiting global warming is essential to investors, suggests a new report from consulting firm Mercer, which calls on institutional investors to act on the prospect of climate change.

The firm published a report on Tuesday that models three different scenarios, examining the impact of average warming of two, three and four degrees Celsius over three timeframes (to 2030, 2050 and 2100). For both investors and the planet, limiting warming to 2°C is ideal, the report found.

“A below 2°C scenario is most beneficial, and the 4°C and 3°C scenarios are to be avoided, from a long-term investor perspective,” it said.

Indeed, if warming can be limited to 2°C, 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, “opportunistic investors can target investment in the many mitigation and adaptation solutions required for a transformative transition,” it said.

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 3°C above the preindustrial average by 2100 could put us beyond the realm of human experience sometime in the next 30 years,” it said.

“A key conclusion is that investing for a 2°C scenario is both an imperative and an opportunity,” said Helga Birgden, global business leader, responsible investment, at Mercer.

“It’s an imperative, since for nearly all asset classes, regions and timeframes, a 2°C scenario leads to enhanced projected returns versus 3°C or 4°C and therefore a better outcome for investors,” she said. “It’s an opportunity, since although incumbent industries can suffer losses in a 2°C 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.”

Additionally, the report noted that asset class returns can also “vary significantly by scenario, 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 to 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 that institutional investors have a fiduciary duty to assess the impact of climate change on their portfolios.

“With recent research showing that 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 that your asset allocation is future-proofed against the risks and uncertainties posed by a warming climate,” she added.