Sustainable investment in action
Critically, the focus of this work is to help guide practical actions that can potentially mitigate previously unrecognized risks or target new opportunities to seek to add return. With robust sustainability-related tools, historically an area of market weakness, our team has sought to take advantage of improving data and measurement to create decision-useful analysis and user-friendly output. The development of these tools follows our megatrends project where we partnered with the Principles for Responsible Investment to identify the key emerging risks and opportunities for investors.1 We highlight three examples across environmental, social and governance (ESG) integration, stewardship and risk/return impact.
We calculate a "resilience" score for a total portfolio. This gauge indicates the total exposure of a portfolio to a wide range of sustainability issues, taking into account major structural differences between different asset classes and public and private markets.
We use big data to identify the sustainability issues that are most material to businesses, regulators and society. We then apply this materiality assessment across a total portfolio by mapping the exposure of different securities and asset classes to these risks.
We also incorporate ESG rating into the gauge to indicate whether individual assets and the total portfolio are positively or negatively exposed to these issues. A risk exposure score relative to portfolio benchmark is the end result (Figure 1).
We believe a fund or portfolio achieving a high resilience score should be less impacted by disruptive sustainability trends over the long term, where resilience can be evaluated in absolute terms or relative to a benchmark or peer group.
Resilience scores can also provide a high-level guide to tilting capital allocation to (or from) areas with higher (or lower) scores, thus enhancing strategic asset allocation decisions.
Source: Willis Towers Watson and MSC
PMA: Private markets alpha
PM: Private markets
Infra: Infrastructure
RE: Real estate
For illustrative purposes only
We use big data and natural language processing algorithms to objectively help identify and track which ESG and technology risks are material to businesses at any point in time. We also analyze how businesses are performing on these topics relative to their peer group. Information on the materiality of these topics comes from companies (via their report and accounts), regulation (which can be voluntary or mandatory) and the news media (i.e., distributed, publicly available information). Topics that are highly material for a company or groups of companies are prioritized in our risk monitoring, which guides areas for potential engagement.
For a global universe of public and private companies, climate change and air quality are material topics for businesses given the high levels of new cross-industry, mandatory and voluntary regulations, and greater societal pressures driven by the news (Figure 2). However, our analysis of this objectively sourced data suggests local community support is not of material importance to businesses in aggregate, despite this being a common area of involvement for their corporate social responsibility teams.
Source: Datamaran, Willis Towers Watson
Scenario analysis helps us understand how assets and portfolios may perform under different states of the world, both favorable and unfavorable. For climate change, this crucially involves considering both physical risks and the risks from a transition to a lower carbon economy, and how these are impacted by action or inaction from global policymakers.
Our initial inclination was to analyze the impact of climate-driven changes top down — by gauging economic costs/benefits and using the information to infer what the most likely and important changes are for asset class prices. This is a useful first step, but it is not sufficient. To properly quantify the impact of climate change on portfolios or businesses, it is also essential for analysis to be undertaken at a microeconomic level — by looking at the impact of physical and transition risks on operational assets and industry profit pools.
Sophisticated reinsurance modeling tools can be applied to investment portfolios to estimate the exposure of individual assets and the total portfolio to a variety of physical perils such as floods, wildfires and cyclones.
We show some sample analysis for a real estate portfolio below. In this case (Figure 3), we have calculated the exposure of each property to a set of natural perils and summarized their risk exposure using a simple one to five risk score. Scores can easily be aggregated across different assets or funds and compared with benchmarks or peer groups. More detailed analysis allows the estimation of the value at risk for individual assets or the portfolio, which calibrates risk in dollar terms using a metric that is familiar to investors.
| Aggregate Risk Score for an Australian Direct Property Portfolio | |||||
|---|---|---|---|---|---|
| Risk by Peril | |||||
| Coastal Flood | 4 | Tornado | 2 | Hailstorm | 2 |
| Earthquake | 2 | Tsunami | 2 | River Flood | 5 |
| Flash Flood | 3 | Wildfire | 0 | Tropical Cyclone | 1 |
| Lightning | 2 | Winter storm | 4 | Volcano | 0 |
| Breakdown by Peril | |||||
|---|---|---|---|---|---|
| Winter storm | Coastal flood | Flash flood | River flood | ||
| Peril score | 2.53 | 1.07 | 3.25 | 2.07 | |
| % Locations | 66% | 33% | 100% | 33% | |
| % Asset valuation | 75.4% | 26.8% | 100% | 26.8% | |
Peril score is an average of each location’s score, weighted by total insured value. Percent exposed indicates the proportion of locations by count or by total insured value with a high risk score for each (3 or higher)
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1. Further detail around these megatrends and accompanying report.
| Title | File Type | File Size |
|---|---|---|
| Sustainable investment in action: Potential solutions for investors | 11 MB |
