Transition today  

Investment decision-making, both today and longer term, includes addressing whether running “green portfolios” to respond to the transition to a net-zero economy can help manage investment risk and opportunity and mitigate the effects of global warming.

At the same time, the physical damages wrought by climate change – with extreme floods, droughts and wildfires now the norm in many regions – are already influencing investment and insurance decision-making, triggering a growing recognition of the importance of adaptation action to increase climate resilience.

This points to the need for a broader definition of the climate transition. This should be one that expands beyond carbon reduction to address the issues of nature loss, physical risks and adaptation. Any definition should also encompass engagement in the circular economy and support for the principles of equality for sustainable development. 

An evolved definition of transition would seek to broaden investment approaches beyond carbon-reduction objectives, considering and incorporating solutions for both mitigation and adaptation to the physical risks of climate change.

Investors typically establish interim and 2050 science-based targets. Increasingly, such targets recognise that natural capital is critical for both mitigation efforts and combatting climate change. We observe that an increasing number of investors are seeking to integrate considerations of natural capital into investment research and analysis to help prevent nature loss and build out solutions. A circular economy supports these aims by encouraging investor allocations to companies that enable maintenance of finite resources. A “fair-share carbon budget,” which allocates the global carbon budget in a manner perceived to be equitable and fair across different countries, is also a key component of transition.

Expanding the definition 

The infographic below presents an expanded view of climate transition, comprising five interrelated issues. Its process is iterative to allow for a better assessment of transition.

A more holistic approach expands the focus from carbon reduction and mitigation to encompass physical risks and adaptation, natural capital, supporting a circular economy, and the principles of equality and sustainable development in capital allocation.

To ease the transition to a net-zero economy, investors can use portfolio tools such as Mercer’s Analytics for Climate Transition (ACT). They can focus on manager and strategy selections that prioritise a wider set of transition risks and opportunities. And they can report progress using the frameworks provided by the Task Force on Climate-Related Financial Disclosures (TCFD) and the Task Force on Nature-Related Financial Disclosures (TNFD).

As case studies show, further key steps include making the following investment decisions:

• Assess each portfolio’s transition capacity.
• Identify areas of higher transition risk.
• Identify engagement priorities.
• Set portfolio-level targets across decarbonisation, exposure to green transition-aligned solutions and engagement activities.
• Align capital allocation with the advice of the International Sustainability Standards Board, TCFD and TNFD. This should be done when selecting and assessing portfolio companies in relation to social and environmental issues. Resource-use issues including (but not limited to) carbon and emissions should also be considered.
• Develop TCFD and TNFD reporting.
• Undertake reporting commitments as part of net-zero, nature and circularity initiatives.
• Review investment manager progress on climate mitigation and adaptation, nature, and circularity issues.
• Set sub-portfolio targets.
• Review proposed benchmark changes for sustainability and climate-aligned indices for index-tracking equity and credit portfolios.