Australian superannuation funds at risk of 46% decline in investment returns due to climate change

Research by Ortec Finance, a leading provider of technology and risk management solutions for financial institutions, has revealed that Australian superannuation funds are highly vulnerable to climate change related transition and physical risks.

As new climate disclosure regulation comes into force in Australia this year, Ortec Finance applied seven possible climate scenarios to a reference portfolio* of the top 30 largest superannuation funds. The scenarios ranged from reaching net zero by 2050 to high warming scenarios where average global temperature rises reach 3.7°C by the turn of the century.

Commenting on the results, Doruk Onal, climate risk specialist at Ortec Finance, said: “In the near term, investment returns for the top 30 superannuation funds could decline by up to 18%** if a disorderly green transition to net zero materializes; however, this reduction risks being eclipsed by a decline of 46%*** by 2050 in a scenario where decarbonization does not occur and severe physical risks continue to accelerate in the longer term.”

Equities sensitive to short-term transition risk

The Australian superannuation industry has a substantial allocation to equities, which are highly sensitive to short-term transition risks.

“The funds are particularly vulnerable to sudden or disruptive transition measures, especially where they have equity investments in energy and carbon-intensive sectors, where regulatory changes or shifts in market dynamics could significantly impact valuations,” said Doruk.

Physical risks more severe in the long term

In the longer-term, the funds’ sizeable exposure to real estate and alternative investments such as private equity and infrastructure, make them highly susceptible to physical risks.

Significant rising temperatures in a high warming stress scenario will lead to an increase in extreme weather events that adversely affect agriculture, labor and industrial productivity. Under this scenario, real estate and equities, which together typically comprise more than half of a superannuation fund’s portfolio, could bring in 60-70%*** lower returns than anticipated.

Mitigating long-term physical risks: Strategic considerations to invest in low-carbon transition

"Based on the insights derived from our most extreme scenarios—which underscore the significant risks associated with maintaining a carbon-intensive investment strategy in the long term—superannuation funds should consider investing in and enabling a strategic transition to a low-carbon economy. If they decide to go down this path, they can contribute to mitigating some of the future physical risks of unaddressed climate change while potentially unlocking new investment opportunities that contribute to stable long-term returns. However, a key challenge remains,” added Doruk. “What measures can effectively guide the global economy on the path to transition?"

As the regulatory landscape becomes more transparent with the new Corporation Act 2001 climate-related financial reporting requirements in accordance with Australian Sustainability Reporting Standards (ASRS), as well as market dynamics, superannuation funds that are unprepared may face increased risks of stranded assets or decreased asset values.

Additionally, some stakeholders have raised concerns about potential litigation risks for superannuation funds that do not consider climate risks in their investment strategies.

Beneficiaries and other stakeholders might seek legal recourse if they believe their interests are not being protected in light of known climate risks.

Ultimately, the ability of Australian superannuation funds to anticipate and adapt to climate-related risks will be important for achieving sustainable, long-term growth and fulfilling their fiduciary duties.

For more detail and statistics, please refer to the full report.

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^{*Reference portfolio represents the average allocation of a top 30 Australian superannuation fund by AUM.
**Figure derived from Ortec Finance’s Net Zero Financial Crisis Scenario Stress
***Figure derived from Ortec Finance’s High Warming Scenario Stress}