European pensions funds’ awareness of, and desire for, action on climate change related investment risk has surged, Mercer says.
The consultant's 2020 European Asset Allocation insights report - which surveyed 927 institutional investor clients across 12 countries during the final quarter of 2019 and the first quarter of this year - found 54% of those surveyed are now actively considering the impact of such risks in their investment allocations, compared to just 14% in 2019.
Mercer's research also found that the overwhelming majority (89%) of schemes surveyed now consider wider ESG risks as part of their investment decisions, up from 55% in 2019.
While regulation continues to drive investors' concern with ESG risk (85%), Mercer's research shows that a growing number are driven by the potential impact on investment returns (51%, up from 29%). Some 40% of schemes also cited the desire to mitigate potential reputational damage as a reason to consider ESG risks, and 30% noted the wish to align with the sponsoring company's existing corporate responsibility strategies.
Mercer European director of strategic research Jo Holden said: "It is encouraging to see such a strong increase in ESG risk awareness, including the potential impact of climate change, on the part of institutional investors.
"It has long been our view that these factors should not be afterthoughts, but rather actively considered in all investment strategy decisions. To enable long-term mindset changes however, investors must realise the value for themselves. We can see this awareness emerging as more schemes and company sponsors witness how ESG risks in their portfolios may impact investment returns and how the company and scheme is perceived by the public."
Holden added: "Investor portfolios can often be improved from an ESG perspective with only relatively minor steps, for example there are quick wins to be made by switching out a relatively small proportion of investments. We encourage schemes to consider developing a climate transition schedule for their portfolios and adopting responsible investment indices."
More generally, Mercer's research shows that investors across Europe and the UK continue to diversify away from equity exposure.
It said investors are instead aiming to diversify their portfolios and protect against market volatility by increasing allocations to growth fixed income (10% increase), real assets (4% increase) and private equity (6% increase).
And, although it found some investors are disinvesting from equities, many are seeking diversification by increasing allocation to emerging markets, small cap and low-volatility equities. More investors are focusing on factor-aware strategies through balanced or targeted exposure to the factors underlying equity returns.
Investors across Europe are also increasing currency hedging within equity portfolios, with 42% hedging over 60% of their foreign currency exposure in listed equity portfolios, compared to 26% in 2019.
Despite this, in the UK, the average equity exposure of plans fell again - to 18% (from 20% the previous year).
Mercer strategic research specialist Matt Scott said: "A number of the UK specific results from this year's survey are what we would expect from its maturing defined benefit pension landscape. With most plans closed to accrual, and ageing in nature, we see an increasing number of plans becoming cashflow negative, and dialing down equity exposure.
"This brings new challenges to plans, particularly with respect to strategies for matching cashflows required. Fortunately, we see less plans disinvesting assets ad-hoc to meet these cashflows and instead proactively looking to match up flows from income-producing assets. A strong 2019 for growth assets has also resulted in more plans now targeting solvency or buy-out of some, or all, of their plan liabilities."
The hit to markets following the Covid-19 pandemic came after the data collected for this year's research; however, Mercer expect the survey results to be largely unchanged due to the effect of both rebalancing policies and market recovery.
Holden concluded: "The long-term impact of Covid-19 is yet to play out, in many aspects the effects are sectoral as opposed to necessarily asset class based. Going forward investors are likely to look for opportunistic investment in distressed assets, potentially in real estate and in private market secondaries. However, the institutional investor base relies on long term strategic asset class mixes and are unlikely to ‘bet the farm' on tactical plays."
BREAKING: Government consults on proposals to force largest schemes to publish climate risk disclosures
The government has put forward proposals to require the 100 largest occupational pension schemes – those with £5bn or more in assets and all authorised master trusts – to publish climate risk disclosures by the end of 2022.
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