UK institutional investors have more than £1trn exposed to climate risks, with around half facing serious threats to the valuations of their portfolios.
That is according to a report from Lane Clark & Peacock (LCP), which contains a comprehensive climate risk profiling of more than 300 institutional investors.
Based on exposure to five types of climate risk – equity, credit, data availability, transparency and asset transition – the analysis suggests that just one in 10 asset owners’ portfolios contain low levels of risk.
Some of the largest threats come from investments in corporate bonds, multi-asset and private markets, with 82% of investors holding more in corporate bonds and gilts than they do in equities, averaging 54% of their investments.
The report also reveals that two-thirds of investors hold more than a tenth of their assets in private markets or multi-asset mandates.
“These types of investments can present serious climate risks,” said Dan Mikulskis, partner at LCP. “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.”
Despite these risks, LCP’s analysis suggests that 90% of institutional investors could significantly reduce their exposure over the next decade through changes to their investment decisions.
Around 75% of their assets are held in listed equities, investment grade corporate bonds and government bonds – all of which have realistic pathways to net-zero emissions and lower climate risks.
LCP's report urges asset managers to increase transparency across all investment products, particularly those in private markets, and for managers of private assets to take a clearer stance on net-zero alignment.
In actively managed equity and credit strategies, the firm said that better reporting of carbon intensity and alignment metrics would help investors compare mandates and take a more informed overall view on their portfolio.
“Our analysis should act as a code red warning to UK institutional investors,” said Mary Spencer, partner at LCP. “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 managers can make informed decisions.”
Image credit: iStock
Author: Chris Seekings