Percentage of European pension funds taking climate risks into account quadruples in 12 months

Climate change

Over half of European pension funds say they now actively incorporate climate change-related factors into their allocations when making investment decisions. 

The proportion of pension funds taking climate change into account, 54 per cent, has more than tripled since last year, when only 14 per cent said they did, according to Mercer’s European Asset Allocation insights report.

In recent months, Europe’s largest pension funds have been revamping their investment in line with environmental risks. In July, Danish scheme PenSam shifted EUR2 billion into a climate-focused global equity mandate, and the UK’s largest pension scheme, the Universities Superannuation Scheme, began divesting from fossil fuels.

Mercer’s survey of 927 institutional investors controlling total assets of around EUR1.1 trillion, also found that 89 per cent of schemes surveyed consider wider environmental, social and governance (ESG) risks as part of their investment decisions. This has risen from 55 per cent in 2019. 

The main driver of investors’ concern with ESG risk was the regulatory environment, while 51 per cent also said they were driven by the potential impact on investment returns, which has risen from 29 per cent in 2019. 

According to recent data from Morningstar, almost six out of 10 sustainable funds in Europe delivered higher returns than their non-ESG counterparts over a decade.

Pension funds also cited the desire to mitigate potential reputational damage as a reason to consider ESG risks, and 30 per cent noted the wish to align with the sponsoring company’s existing corporate responsibility strategies.

“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,” says Jo Holden, European director of strategic research at Mercer. 

These factors should not be afterthoughts, says Holden, but rather should be 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 are perceived by the public.”

Holden adds that investor portfolios can often be improved from an ESG perspective with “only relatively minor steps”, such as switching out a relatively small proportion of their investments. “We encourage schemes to consider developing a climate transition schedule for their portfolios and adopting responsible investment indices.”

More generally, Mercer’s 2020 research shows that investors across Europe and the UK continue to diversify away from equity exposure. Investors are diversifying their portfolios and protecting against market volatility by increasing allocations to growth fixed income (10 per cent increase), real assets (4 per cent increase) and private equity (6 per cent increase). 

Some investors are also seeking diversification within the asset class, by upping their allocation to emerging markets, small cap, and low-volatility equities. 

In the UK, the average equity exposure of plans fell again, down to 18 per cent from 20 per cent the previous year. 

Matt Scott, co-author and strategic research specialist at Mercer, explains: “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 dialling 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.”