Ortec Finance, a leading provider of technology and risk management solutions for financial institutions, has found that disruptive climate policies could affect European pension fund investment returns by up to 16%* in the short term, while an increase in the number of extreme weather events resulting from a lack of action could have more far-reaching consequences with declines of up to 34%** by 2050.
These findings are revealed in Ortec Finance’s inaugural European pension fund climate risk report, in which it has analyzed the impact of climate change on a reference portfolio*** of European pension funds, representing their average asset allocation.
“In the event of a disruptive transition, equity investments would be the most impacted, potentially suffering a 25%* drop in returns, followed by alternative and real estate investments, while fixed income investments will be more resilient,” said Doruk Onal, Climate Risk Specialist at Ortec Finance.
In the longer term, rising carbon emissions in the absence of further decarbonization efforts could cut real estate and equity portfolio returns by half by 2050, leading to significant financial strain on pension funds highly exposed to these assets and increasing pressure on funding levels and pension payments.
“Further rising temperatures, leading to an increase in extreme weather events and affecting agricultural, labour and industrial productivity, will have 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 comprise more than half of a typical European pension fund’s portfolio, could yield only half of the expected returns,” added Doruk. “Investments in well-diversified fixed income indices remain resilient against long-term climate impacts; however, more targeted fixed-income investments could experience significant drawdowns and face notable losses due to deteriorating credit ratings and defaults.”
Applying seven possible climate scenarios, which include the impact of climate tipping points in its high warming scenarios, Ortec Finance’s research found that transition risks are likely to be the dominant climate risk from 2025 to 2030. The cumulative impact of additional low-carbon policies, revised Nationally Defined Contributions and net zero target reviews by global investor alliance groups could accelerate the stranding of fossil fuel assets, triggering market overreactions and widespread disruption. Under the most extreme outcomes of a disorderly transition, this could result in a 16%* reduction in investment performance in the near future, followed by a moderate pace of recovery thereafter.
While short-term cumulative returns for an average European pension fund due to low-carbon policies and decarbonization activities could decline by 16%*, this reduction is less than half of the potential decline of up to 34%** in a scenario where active decarbonization does not occur in the near future. Losses are likely unavoidable in all scenarios, but the extent of these losses will depend on the time horizon in which they occur.
For more detail and statistics, please refer to the report.
*Figure derived from Ortec Finance’s Net Zero Financial Crisis Scenario Stress
**Figure derived from Ortec Finance’s High Warming Scenario Stress
***Reference portfolio represents the average allocation of a European pension funds. This allocation is derived from the EIOPA (European Insurance and Occupational Pensions Authority) Reference Portfolios, with data released in March 2023.
Contact
Doruk Onal
Climate Risk Consultant