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Implications of climate change for pension funds

Published Nov 5, 2019



A publication by Alexander Forbes’s global strategic partner, Mercer, has revealed the stark realities of the impact of climate change on the planet, with devastating consequences on virtually everything from daily lives, to agricultural production and water resources.

“Investing in a time of climate change - the sequel 2019” represents three climate change scenarios: a 2°C, 3°C and 4°C average warming increase on pre-industrial levels. This showcases the expected impacts of natural catastrophes and resource availability for each temperature increase (see table).

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According to the report, a 2ºC rise in temperature would result in significant losses between now and 2030 in coal, oil and gas, resulting in opportunities for higher returns on renewable energy investments.

If a child with a two-degree rise in temperature is fever struck, imagine how an unabated temperature rise affects the planet, including its fauna and flora.

Extreme weather patterns affect agriculture production and water resources, ultimately affecting the sustainability of society and the environment. It’s only a matter of time until these tangible effects begin to influence asset classes and therefore investment returns. South Africa is already a water-scarce country and agricultural output is a key contributor to the gross domestic product of the economy.

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Three degrees of warming would cause negative returns for almost every sector, including financials, agriculture, industrials and consumer staples. The damage would be irreversible should we continue ignoring the signs up to 2030.

The current trajectory could put us beyond a temperature that humans have ever experienced, some time in the next 30 years. The last time the global mean surface temperature was comparable to today was more than 100000 years ago. The last time carbon dioxide concentrations were as high as today (over 400 parts per million) was three to four million years ago, and the last time the world was 4°C warmer was more than 10 million years ago. It’s possible that we could reach 4°C of warming by the end of the century. Humans have never existed in a warmer time.

According to independent scientific analysis produced by Climate Action Tracker, South Africa is falling short of its commitments made at the Paris Accord in 2016. Therefore, a paradigm shift is required in the South African asset management industry to take quality longer-term investment decisions.

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“The pension funds and climate risk” report by activist organisations Just Share/Client Earth and accompanying legal opinion from law firm Fasken require South African pension fund boards to consider climate change risks in their investment decisions.

A failure to consider material risks arising from climate change would likely amount to a breach of fiduciary duty by the board of a pension fund, under both regulatory frameworks and common law principles. Although not binding and ruling, the spirit of the report and opinion as well as the conversations that it has prompted in the industry.

Funds can practically begin managing these risks by considering the following:

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* Beliefs, policy, process, portfolio.

A fund should define its investment beliefs, including responsible investment. The beliefs should be articulated in a policy. The portfolio should be managed and reviewed in accordance with the policy.

* Be an active steward (active ownership and voting practices).

Use influence as shareholders positively to affect a company’s conduct through engagement and proxy voting. Do not stop there; it is more critical that you disclose the voting outcomes and reasons for supporting or going against matters.

* Allocate to thematic investment.

Invest in assets specifically related to sustainability, such as solar, wind, geothermal energy, sustainable infrastructure, impact investing and green bonds. Also, ensure that there is a reporting framework in place that assists in monitoring and measuring the real impact these investments are having.

* Use positive and negative screening.

Include or exclude companies from share selection according to climate change criteria, for example distinguishing between low and high carbon investments.

* Disclose carbon exposures and carbon tax valuation.

Ensure that listed companies disclose their carbon exposures and taxes. The users of financial statements should integrate these financial measures in their assessment of the value they attribute to the companies.

The South African pension fund industry and average fund member is probably under-equipped to attend to these risks, but attempting to be proactive around climate change is helpful to long-term fund solvency and is encouraged by the regulatory environment. Being conscious of where the rands and cents of pension funds are ultimately going will encourage more sustainable allocation of assets.

Premal Ranchod is manager research analyst at Alexander Forbes Investments.


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