This paper aims to help the growing number of investors that have committed to or are considering the Divest-Invest pledge as a means of addressing climate change risks, by assessing the potential impacts of aligning a portfolio with the pledge from an investment risk-return perspective. Although there are many different ways an investor can manage climate change-related risks or reduce portfolio exposure to carbon, this paper focuses specifically on the approach adopted by Divest Invest signatories — namely, divesting from fossil fuel reserve owners and reinvesting in climate solutions (that is, positively allocating capital to areas aligned with the transition to a low carbon economy).
The paper considers the following key questions:
To understand the impact of fossil fuel divestment or investment in climate solutions on portfolio risk/return, practitioners naturally first turn to the historical record, though the question remains as to the extent to which past data can be relied on to make long-term predictions regarding the future impacts of climate change — a phenomenon that has not yet fully manifested and has no comparable proxy in history. It is also unclear to what extent markets are currently pricing climate change into valuations and what potential large changes in policy, technology and weather patterns may unfold over the coming years and decades. Given these challenges, it is helpful for investors to utilize a scenario framework to look forward and ask “What if?”
This research leverages and relies upon Mercer’s climate change modeling framework described in detail in the 2015 report Investing in a Time of Climate Change.
We employ this modelling framework to estimate the return impact on sustainable iterations of core asset classes, including US and international equities, investment grade credit, infrastructure and private equity.
These asset classes are analyzed as part of the following three portfolio approaches, each of which has been modeled after the typical asset allocation of a small (<$101 million) US foundation:
We then run these portfolios through our asset allocation model under two scenarios and compare the results: