ESG risk mitigation rises up agenda

European pensions funds’ awareness and desire for action on climate change-related investment risk has surged, according to new research.

More than half of schemes are now actively considering the impact of climate risks in their investment allocations, according to Mercer’s latest European Asset allocation insights survey, compared to just 14% in 2019.

While regulation continues to drive investors’ concern with ESG risk, the research showed that just over half are driven by the potential impact on investment returns, up from 29% last year. Forty per cent of schemes also cited the desire to mitigate potential reputational damage as a reason to consider ESG risks.

“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,” said Jo Holden, European director of strategic research at Mercer. “It has long been our view that these factors should not be afterthoughts, but rather actively considered in all investment strategy decisions.”

However, to enable long-term mindset changes, investors must realise the value for themselves, she added. “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, said Holden.

“We encourage schemes to consider developing a climate transition schedule for their portfolios and adopting responsible investment indices,” she added.

More generally, the research revealed that investors across Europe and the UK continued to diversify away from equity exposure. Investors are aiming to protect against market volatility by increasing allocations to fixed income, real assets and private equity.