Why you can’t ignore climate change with your portfolio

Regardless of whether you like the idea of investing in green technologies, it's increasingly clear that you can't ignore the impact of climate change on your investments. Earlier this month, the Group of Seven industrial nations signed a deal aimed at eliminating fossil fuel emissions by the end of this century, after years of failed talks. And while many environmentalists say this deadline is far too far in the future, the consequences for sectors such as oil and coal are likely to be evident much sooner.

Tellingly, the $900bn Norwegian sovereign wealth fund which has been funded entirely out of Norway's oil wealth is already taking action.The fund recently sold more than £5bn of coal investments in 122 companies, including a $956m holding in UK utility SSE and a $49m stake in power station Drax. It joins a growing number of institutions that are divesting stakes in companies seen as contributors to climate change, or those that are likely to be affected by tough rules.

Many fund managers are unsure of how to respond to this shift, says Chris Flood in the FT. Deciding which sectors to avoid or invest in onthe basis of climate change isn't easy, especially when the long-term impacts are so uncertain. Consultants at Mercer analysed what the effect on returns could be if global temperatures rose between two degrees and four degrees above pre-industrial levels by 2050.

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Far from being all doom and gloom, they found that a two-degree increase could boost returns from assets such as emerging-market shares, agriculture and timber, property and infrastructure. But if temperatures increased by four degrees, then changing weather patterns would be likely to hurt most asset classes.

Still, there are some obvious steps that investors could consider. First, the coal industry is under threat: coal producers could see as much as an 18% to a 74% drop-off in returns in the next 35 years, says Mercer.

The renewables sector is likely to benefit, and could see returns increase by between 6% and 34% (although we'd note that investing in hot sectors can often deliver surprising poor long-term returns). More tenuously, growth assets could be more vulnerable to climate change than defensive ones, while energy-intensive heavy industry could be more vulnerable to higher costs.

If you're keen to ensure your portfolio is weighted towards companies that are least exposed, one possible option could be a "low-carbon" thematic fund, such as the iShares MSCI ACWI Low Carbon Target ETF (NYSE: CRBN).