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Written by: Ortec Finance
Research by Ortec Finance, a leading provider of technology and risk management solutions for financial institutions, has revealed that US pension funds are among the most vulnerable to climate change compared to other advanced economy funds.
Doruk Onal, climate risk specialist at Ortec Finance and author of the report, said: “US pension funds are expected to experience the most significant impact from both transition and physical climate risks. With a heavy reliance on high-risk assets like equities and alternative investments such as private equity and infrastructure, these funds could face investment return declines of up to 50%* by 2040 if climate policies remain unaddressed.”
This exposure to equities also makes US pension funds particularly vulnerable to sudden or disruptive net zero transition measures, especially in energy and carbon-intensive sectors, where regulatory changes and shifts in market dynamics could significantly impact valuations and lead to rapid stranding of fossil fuel assets.
“Transition related risks remain the dominant risk in the short term,” said Doruk. “In the most extreme scenarios, a sudden realization of disruptive climate policies could spark a financial crisis with investment returns declining by up to 19%** between 2025 to 2030.”
In its net-zero financial crisis scenario, pension fund equity investments would be most impacted, reducing by up to 25% by 2030 as market overreactions and sentiment shocks from a mass sell-off of carbon-intensive assets trigger liquidity challenges and abrupt price fluctuations as markets adjust asset valuations.
These findings are revealed in Ortec Finance’s inaugural US pension fund climate risk report, in which it applied seven possible climate scenarios to a reference portfolio*** of 30 US pension funds. The scenarios ranged from reaching net zero by 2050 to high warming scenarios where average global temperature rises reach 3.7 degrees by the turn of the century.
In the longer term, it is anticipated that unrestrained increases in carbon emissions in the absence of further discernable decarbonization will increase levels of physical risk, leading to severe financial impacts by the mid-2030s. In a worst-case scenario, returns in the portfolios of the top 30 US pension funds could decline by up to 53%* in 2050.
Significantly rising temperatures, as explored in the high warming scenarios, lead to an increase in extreme weather events and adversely affect agricultural, labor, and industrial productivity. This has a profound and widespread impact on economies, collectively reducing asset performance across all asset classes.
“Under this scenario, alternative assets, real estate, and equities, which together typically comprise more than 70% of an average Top 30 US pension fund’s portfolio, could bring in up to 73% lower returns than anticipated,” said Doruk.
The decline in investment returns has serious implications. For pensioners, reduced returns could lead to lower retirement benefits and financial insecurity. Sponsors, including corporations and government bodies, might face increased contributions to cover shortfalls, impacting their financial health. Employees could also be affected by lower pension fund performance, leading to potential adjustments in retirement planning and expectations. Additionally, some stakeholders have raised concerns about potential litigation risks for pension funds that do not consider climate risks in their investment strategies. There is the potential that beneficiaries and other stakeholders might seek legal recourse if they believe their interests are not being protected in light of known climate risks.
*Figure derived from Ortec Finance’s High Warming Scenario Stress
**Figure derived from Ortec Finance’s Net Zero Financial Crisis Scenario Stress
***Reference portfolio represents the average allocation of a top 30 US pension fund by AUM.
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