European pensions funds’ awareness of, and desire for, action on climate change related investment risk surges, according to Mercer’s latest European Asset allocation insights, with 54% of those surveyed now actively considering the impact of such risks in their investment allocations, compared to just 14% in 2019. Through its regular Investing in a Time of Climate Change report, Mercer has been engaging with clients on this topic, and the firm expects the trend to continue as more schemes consider the potential portfolio impacts of climate change over the coming years.
Mercer’s research also found that the overwhelming majority (89%) of schemes surveyed now consider wider environmental, social and governance (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%). Forty percent 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.
Jo Holden, European Director of Strategic research at Mercer, 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.
“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.”
Mercer’s 2020 European Asset Allocation insights – the 18th edition – surveyed 927 institutional investor clients across 12 countries, reflecting total assets of around €1.1 trillion. Mercer’s annual survey provides a comprehensive overview of investment strategies across the European pension industry, identifying emerging trends in institutional investor behaviour.
More generally, Mercer’s 2020 research shows that investors across Europe and the UK continue to diversify away from equity exposure. 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). Although 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.
In the UK, the average equity exposure of plans fell again– to 18% (from 20% the previous year). Matt Scott, co-author and strategic research specialist at Mercer, explained: “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. Ms 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 rely on long term strategic asset class mixes and are unlikely to “bet the farm” on tactical plays.”