There is a direct link between climate change and investment returns

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

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

Today, this is more important than ever. The recent floods in KwaZulu-Natal as well as increasing unrest as a result of inequality are good examples that sustainability considerations are increasingly important and require today’s generations to address the issues for the benefit of future generations.

Being proactive to address 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 affected to a greater extent with every 1 degree of warming that occurs compared to temperatures at pre-industrial levels. A 1% per year effect on returns is plausible for South African investors and the effect of this will be felt by future generations when they retire as illustrated in the following graph:

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

At present, the aggregate of current policies globally and the nationally determined contributions (NDCs) of each country (pledges made to reduce greenhouse gas emissions) are insufficient to reach below 2 degrees Celsius. Beyond this point the damage created by climate change is too severe. As a result, there is an increased risk of a disorderly transition where more steps will need to be taken globally in a sudden and disruptive manner to avoid the physical risks – such actions will therefore lead to increased transition risks.

Under a disorderly transition scenario, the potential loss in value of a typical retirement fund balanced portfolio is expected to be a reduction of approximately 17%.

Hence climate risk is a material issue affecting everyone, including retirement fund members and their investments. They need to ensure that the risks are appropriately managed and take advantage of the various investment opportunities presented from the world moving to a greener economy.

Adopting a responsible investment approach

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

Applying responsible investment principles is most effective when it is 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 captured throughout the investment process
• demonstrate active ownership to improve the governance of underlying investments directly or through asset manager monitoring, manager selection, voting practices and engagement
• construct portfolios that target sustainable benchmark-beating returns (responsible outperformance) to safeguard investors, as well as the community and environment within which investors operate

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

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

The sustainability agenda around the world is rapidly moving, with key issues linked to risks and returns affecting long-term investment returns. South Africans therefore need to prioritise their future by concentrating on responsible investing. Companies should begin to consider how their business can manage the risks and opportunities in relation to sustainability considerations and how they can contribute positively towards South Africa’s national goals. Investment advisors and independent multi-managers can assist retirement funds to structure investment strategies to ensure that for a given level of risk the best returns are achieved whilst at the same time also providing a positive impact to the economy and support future generations.

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