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There is a direct link between climate change and investment returns

We need to focus on the role that sustainability plays in changing the landscape for future generations.

In 1987, the United Nations Brundtland Commission defines sustainability as “meeting the needs of the present without compromising the ability of future generations to meet theirs”.

Today it is more important than ever. The recent floods in KwaZulu-Natal as well as growing unrest over inequality are good examples of how sustainability considerations are increasingly important and compel today’s generations to solve problems for the benefit of future generations.

Being proactive in the face of climate change

There is a direct link between climate change and investment returns. It is clear that emerging markets such as South Africa will be hit harder with each degree of warming relative to pre-industrial temperatures. A 1% per year effect on returns is plausible for South African investors and the effect will be felt by future generations when they retire, as illustrated in the following chart:

Source: Alexforbes calculations based on actual returns between 5% and 7% per year for a typical retirement fund accumulation portfolio

Currently, the current global policy package and each country’s Nationally Determined Contributions (NDCs) (commitments made to reduce greenhouse gas emissions) are insufficient to achieve less than 2 degrees Celsius. Beyond this point, the damage created by climate change is too great. As a result, there is an increased risk of a disorderly transition where more action will need to be taken globally in sudden and disruptive ways to avoid physical risks – such actions will therefore lead to increased transition risks.

In a disorderly transition scenario, the potential loss in value of a typical balanced portfolio of a pension fund is expected to be around 17%.

Climate risk is therefore a material issue that affects everyone, including members of pension funds and their investments. They must ensure that risks are managed appropriately and take advantage of the diverse investment opportunities presented by the world in transitioning to a greener economy.

Adopt a responsible investment approach

Alexforbes defines responsible investing as an investment approach that aims to integrate environmental, social and governance (ESG) factors, broader systemic themes (climate change and sustainability) and stewardship into the investment decision-making process. . This allows South Africans to better manage risk and generate long-term sustainable investment results.

The application of responsible investment principles is most effective when integrated into a standard investment process, providing an additional layer of insight and oversight. The process aims to:

  • mitigate portfolio risk by ensuring ESG factors are considered throughout the investment process
  • demonstrate active ownership to improve governance of underlying investments directly or through asset manager oversight, manager selection, voting practices and engagement
  • build portfolios that target sustainable returns above benchmarks (responsible outperformance) to protect investors, and the community and environment in which investors operate

South Africans who integrate these factors into their decision-making process are better at:

  • informed of the underlying risks and opportunities
  • positioned to make quality investment decisions that are more likely to mitigate risk and enhance investment returns

The sustainability agenda around the world is rapidly changing, with key risk and return issues affecting long-term investment returns. South Africans must therefore prioritize their future by focusing on responsible investment. Businesses should start thinking about how their business can manage the risks and opportunities related to sustainability considerations and how they can positively contribute to South Africa’s national goals. Investment advisors and independent multi-managers can help pension funds structure investment strategies to ensure that for a given level of risk, the best returns are achieved while having a positive impact on the economy and supporting future generations.

John Anderson, Head of Investments, Products and Enablement at Alexforbes.