In a low-yield environment, investors seek alternative investments to bolster their long-term-risk-adjusted returns. Real assets — investments tied directly to tangible properties, generally in the real estate, infrastructure, and natural resource sectors — offer one such alternative, which is becoming increasingly attractive to investors. However, such investments are not without risk and are on the front lines of climate change given their direct exposure to extreme weather and their reliance on functional and efficient insurance markets for financing.
Real assets are evolving from an alternative to a mainstream asset class, with portfolio allocations increasing from roughly 5% to 10% in 2012 to as much as 30% by 2030. At the same time, this tilt toward real assets is being met by several international efforts to encourage institutional investors to improve their accounting of environmental risk. Recent UNEP FI publications highlight the need for “Environmental Stress Testing” of investor portfolios, and a consortium of organizations under the umbrella of the UN recently launched the “1-in-100 Initiative” aimed at integrating catastrophe risk analysis into investor planning and regulatory oversight. Both of these efforts acknowledge the leadership of the (re)insurance industry with respect to the use and integration of catastrophe risk analysis into their liability management.
The risks of insurance market disruption (manifested as capacity shortages and/or premium increases) or un(der)insured damage to the assets underlying real asset investments as a result of climatological and demographic shifts are significant and need to be addressed by institutional investors. These risks are only intensified by the relative illiquidity of many real asset investments.
Applying the proprietary climate risk factor modelling framework developed by Mercer for its ground-breaking Investing in a Time of Climate Change study to your portfolio will provide unique insights regarding embedded future climate change risk. The financial information produced by this modelling approach can be used by investors to develop a foundation from which to evolve their investment processes and portfolio in the near and long term to be attendant to a material and complex environmental issue.