How a Pension Fund Will Fare in a Low-Carbon Economy

Reducing emissions won’t be easy on equity-heavy investors like CalSTRS—but it’s still better than the alternative, Mercer reports.

The California State Teachers’ Retirement System (CalSTRS) could lose as much as $123 billion by 2050 as a result of climate change policies necessitated by the Paris Agreement, according to Mercer.

While the $179.4 billion pension fund is “reasonably well insulated” against scenarios in which temperatures rise above 2 degrees Celsius, a Mercer assessment found that the “strength and scale of response” required to keep global warming below that benchmark would expose CalSTRS to significant equity losses.

“CalSTRS is already dedicated to climate change risk management, as evidenced by the many activities undertaken by its Green Team,” said Jane Ambachtsheer, global chair of responsible investment at Mercer. “This report will give CalSTRS the opportunity to build upon its strong foundation as a ‘future maker’ and embed climate risk considerations across its portfolio of investments.”

In particular, Mercer said US and developed-market equities—which make up up nearly half of CalSTRS’ total exposures—would be negatively impacted by policies aimed at preventing a temperature increase above 2 degrees, as companies would have to significantly reduce their emissions in short time span. When private equity is also taken into account, exposures with significant negative impacts over 35- and 10-year horizons “would account for more than 60% of CalSTRS total fund,” Mercer said.

To address these risks, the consultant recommended that CalSTRS reallocate some passive exposures toward lower-carbon indexes, allocate a larger portion of active equities to managers focused on sustainability, and increase its exposures to emerging market equity.

If the Paris Agreement and other efforts fail to enact sufficient action, and temperatures rise by 4 degrees or more, Mercer warned that severe environmental consequences could also damage CalSTRS’ portfolio. In this scenario, the pension fund could lose $83 billion by 2050.

This outcome would only worsen beyond 2050, Mercer noted, as unabated global warming would be “increasingly detrimental to returns over time,” while successful climate change action becomes “increasingly favorable relative to the other scenarios.”

“To achieve a key element of the December 2015 Paris Agreement—keeping the increase in global average temperatures well below 2 degrees Celsius relative pre-industrial levels—necessitates an expansion of policy action,” said CalSTRS CEO Jack Ehnes. “For institutional investors like CalSTRS, supportive policies will ease our ability to deploy appropriate capital to the market.”

    calstrs mercerSource: “Investing in a Time of Climate Change: California State Teachers’ Retirement System Portfolio Climate Change Risk Assessment”

Related: How to Make Money from a Changing Climate; Pensions of the World Unite on Climate Change; Pensions Urge ‘Strong Action’ over Climate Change in Paris