How is climate change affecting scheme investments now?

To take China as a case in point, the largest global emitter has committed to its emissions peaking by 2030, and its use of coal has actually been falling for the past two years.

How is this relevant to investors?

The changing energy picture impacts most directly on investments in the three sectors with the greatest exposure to fossil fuels: oil and gas, mining, and utilities.

The Financial Stability Board’s Task Force, established by Bank of England governor Mark Carney, looks likely to publish recommendations for climate disclosure by both corporates and investors

For the extractives sectors, stock market valuations are driven not only by revenues from current and planned operations, but also by reserves – fossil fuels still in the ground that could be exploited at some future date.

However, the commitments now made by governments raise questions over whether the changes in future demand will be so great as to leave these reserves uneconomic to extract – raising the risk that they will become ‘stranded assets’.

Utilities companies face similar stranded asset risk, as legislation renders power plants obsolete before their planned retirement date.

Mercer has estimated that under a scenario where strong policy action is taken to limit emissions over the coming decade, utility sector returns could fall to 1.2 per cent from 5.1 per cent a year over the next 10 years, with corresponding increases in returns to renewable energy industries.

Over a longer 35-year timescale, they estimate that annual returns for the oil and gas sector could decline to 2.5 per cent a year from 6.6 per cent.

The weight of these three sectors in the FTSE 100 has already been in decline over the past decade, falling to 25 per cent of the index from almost 36 per cent, crowded out by higher-growth sectors including consumer goods and healthcare.

For investors, the key question is whether shifting energy policies could accelerate this decline – and if so, what steps need to be taken to protect themselves against the associated risks.

So what can pension funds do?

The first hurdle is information. As investors, we currently lack sufficient information from companies about their exposure to long-term energy market changes, and how they plan to adapt their business strategies in response.

Asking for better disclosure was the aim of shareholder resolutions filed over the past two years; some companies, such as BHP Billiton, Shell and BP have responded positively, but others, notably ExxonMobil and Chevron, have resisted.

The next step is translating this into an understanding of the exposure of individual pension funds to risk.

A range of tools and research are available, from carbon footprinting to portfolio stress-testing models – but this can be a daunting task, and outside the usual experience of the pension fund trustee.

However, simple practical steps are available. Pension schemes can raise the issue with their asset managers to see what measures they are taking to manage the risks. And they can collaborate with peers to build knowledge – informally, or through networks such as the Institutional Investors Group on Climate Change.

Finally, as investors ask companies for better disclosure, so investors themselves are likely to come under greater scrutiny. Already, French pension schemes are required by law to explain whether their investment strategies are aligned with national and international climate change policy.

The Financial Stability Board’s Task Force on Climate-related Financial Disclosures, established by Bank of England governor Mark Carney, looks likely to publish recommendations for climate disclosure by both corporates and investors.

Pension funds are used to thinking about how factors such as interest rates, GDP and exchange rates will impact on their ability to deliver long-term returns.

Now is the time to add climate change to that list, as a global macroeconomic trend that could either threaten returns – or create positive investment opportunities in companies and sectors that are providing solutions.

Vicki Bakhshi is head of governance and sustainable investment at BMO Global Asset Management