The analysis, which was conducted by consultancy LCP for its report The tip of the iceberg, analysed the exposure of UK institutional investors to climate risks based on their allocation across asset classes and, therefore, their estimated exposure to the five types of climate risk it has identified (equity, credit, data availability, transparency and asset transition risks).
The analysis demonstrates the pervasive nature of climate risk with just 1 in 10 asset owners’ portfolios containing low levels of climate risk.
Corporate bonds fuel climate risk exposure
According to the report, some of the largest risks come from investments from corporate bonds, multi-asset and private markets.
4 in 5 (82%) UK institutional investors today hold more in corporate bonds and gilts than they do in equities, averaging 54% of their investments. Meanwhile, two thirds of UK institutional investors hold more than a tenth of their assets in private markets or multi-asset mandates.
Dan Mikulskis, Partner at LCP, commented: “These types of investments can present serious climate risks. With spread levels reaching their lowest point for more than a decade, there is a question mark over whether any climate transition risks are realistically priced within corporate bonds. Because of the rising allocation to this asset class and the under-the-radar nature of this risk we believe this is potentially the most significant class of climate risk faced by investors.
“At the same time, in private markets there simply isn’t the data to make any accurate judgements around carbon intensity or climate alignment, making climate risks difficult to quantify and address.”
Opportunity to pivot equities and bond investments towards lower climate risks
Despite these risks, LCP’s analysis reveals that 90% of UK institutional investors could significantly reduce their climate risk exposure over the next decade through changes to their investment decisions.
UK institutional investors hold around 75% of their assets in listed equities, investment grade corporate bonds and government bonds – all of which have realistic pathways to Net Zero emissions and lower climate risks. Furthermore, this overall percentage is likely to remain relatively stable over the next 10 years.
Dan Mikulskis comments: “The good news is that the bulk of investments are in asset classes where climate risk can be addressed with the information we have available today, for example by investing in companies that have forward looking plans that are consistent with the Paris Agreement. Such measures would radically decrease the climate risks associated with these portfolios.”
Greater transparency and climate data needed to drive change
LCP is urging asset managers to increase transparency across all investment products, particularly those in private markets. Managers of private assets must take a clearer stance on Net Zero and communicating how they view alignment in their portfolios in order to keep climate risk down.
In actively managed equity and credit strategies, better reporting of carbon intensity and alignment metrics would help investors compare mandates and take a more informed overall view on their portfolio.
Mary Spencer, Partner at LCP, said: “Our analysis should act as a code red warning to UK Institutional investors. It’s pretty clear that the current trend away from listed equities and towards corporate bonds and private markets could expose investors to climate risk. The good news is that where there is a will there is a way and the majority of portfolios can be significantly improved with existing products and investments. What the industry does need is increased transparency and data over all asset classes so asset managers can make informed decisions.”
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