Climate change could erode Canadian pension fund returns by 44%

Research by Ortec Finance, a leading provider of technology and risk management solutions for financial institutions, has revealed that Canadian pension funds are among the most vulnerable to climate change, second only to the US. 

Doruk Onal, climate risk specialist at Ortec Finance and author of the report, said: “Canadian pension funds are expected to experience significant impact from both transition and physical climate risks. With a heavy reliance on high-risk assets like equities and alternatives, these funds could face investment return declines of up to 44%* by 2050 if climate policies remain unaddressed.”

This exposure to equities also makes Canadian 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 dominant 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 15%** between 2025 to 2030.” 

In its net-zero financial crisis stress scenario, pension fund equity investments would be most impacted, reducing by up to 24% 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.

“In contrast, fixed income assets show more resilience to systemic risks in this horizon. Bondholders may see significant declines in market value as spreads increase during crisis years, which can be material if investors are forced to trade. However, long-term investors holding bonds to maturity generally recover from short-term market value fluctuations when spreads normalize.” 

These findings are revealed in Ortec Finance’s inaugural Canadian pension fund climate risk report, where seven possible climate scenarios are applied to a reference portfolio*** of 30 Canadian pension funds. The scenarios ranged from reaching net zero by 2050 to high warming scenarios where average global temperature rises to 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 Canadian pension funds could decline by up to 44%* 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 the high warming stress scenario, alternative assets and equities, which together typically comprise more than half of an average Top 30 Canadian pension fund’s portfolio, could bring in up to 59% 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. 

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

^{*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 Canadian pension funds by AUM.}