The Dryden Creek Wildfire, just north of Squamish, B.C., on June 11.Tijana Martin/The Canadian Press
Major investors are wrestling with increasing climate-related physical risks within their vast portfolios, forcing them to rethink how to evaluate and manage the impact of storms, floods, wildfires, heat domes and droughts – now and in the future.
Climate risk is not new, but much of the focus has been on the costs of reducing emissions, as well as regulations and policy that could affect companies, real estate holdings and other investments.
Now, increasingly destructive weather is taking a bigger profile as sovereign wealth funds, pension funds and other institutions seek to protect assets and avoid long-term damage to the value of their holdings.
“Most institutions are increasing the focus and capacity that they’re deploying to understanding it – mostly, physical risk happening earlier than expected, with greater impact than was anticipated, and that we are starting to see insurance markets respond, providing an initial transmission mechanism of physical risk into asset prices,” said Richard Manley, chief sustainability officer at Canada Pension Plan Investment Board, which manages $732-billion in assets on behalf of Canadians.
In a recent report, CPPIB cited data showing losses from storms, floods and fires totalled US$400-billion globally in 2024, with Europe and Asia suffering damage to forests, electric systems, agriculture and public health.
Closer to home, destructive wildfires this summer in Manitoba, Nova Scotia, Newfoundland and Labrador and elsewhere scorched structures and took a toll on human health as smoke blanketed numerous regions.
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The insurance industry is responding by raising premiums, tightening policy terms and, occasionally, withdrawing coverage. Investors see it as a signal of “unaddressed exposure,” CPPIB said.
Political upheaval and the election of populist leaders have led to backtracking on climate targets. Europe has paused some of its sustainability reporting.
Some clean energy, meanwhile, is going to powering booming demand from data centres rather than replacing fossil fuels on electricity grids, the report said. Based on current policies, the world is on track for a 3.1-degree increase in global temperatures by the end of the century, according to the United Nations.
In some cases, climate models have underplayed how global-warming effects cannot be reversed, he said. For instance: how chronic heat might affect worker productivity or agricultural yields, or how more frequent and intense storms will damage buildings and other physical assets.
“There is already potentially quite considerable physical risk baked into the economy by the middle of the century and beyond,” Mr. Manley said, “and the most natural place for institutions to be focusing is in their [real estate and infrastructure] portfolios where these assets really cannot be moved to avoid the potential risks to them.”
Another stumbling block for investors is the difference in time horizons of physical risks and investment cycles – that is, climate-related damage plays out over long periods, while typical valuation methods are more likely to focus on near-term policy risk, the CPPIB report said.
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Investors are taking different approaches to the issue. Jennifer Coulson, senior managing director and global head, ESG, for British Columbia Investment Management Corp. (BCI), said physical risk assessment affects both macro and micro calculus.
“We have to be aware of the broad trends and what’s happening, and so physical climate-change risk is captured in the climate change scenario work that we do at the total portfolio level,” Ms. Coulson said.
“But then you really have to understand the implications of that from a bottoms-up perspective as well. As we are making investment decisions, we need to make sure that this is factored into, particularly, some of the hard assets that we would be holding for, in some cases, decades.”
Acquiring the right data, and tools for slicing and dicing it, is a top challenge as BCI looks to prepare for a range of scenarios, she said.
In its recently released Stewardship Report, BCI listed physical and transition risks as its first priority in engagements with portfolio companies, saying they threaten asset value, can increase operational costs and disrupt supply chains.
Many funds are refining their internal investment processes and incorporating climate-adjusted financial modelling into their due diligence.
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Funds are increasingly making use of a range of technology, regulatory engagement and outside data experts to bridge gaps in risk assessment, the CPPIB report said.
It marks a big step toward integrating physical risk into investment decisions. Engagement with corporate boards and managers is a key crucial strategy, and in some cases could mean withholding support for directors if companies fail to address the risks.
One tool CPPIB uses is Climate Value at Risk, a metric developed by financial research provider MSCI that estimates the potential impact of risks on companies by modelling future costs and revenues driven by ranges of policy risks, technological prospects as well as physical risks and opportunities. Future costs and revenues get projected to 2050 for transition-risk scenarios and to 2100 for physical risk.
Last week, Ontario Teachers’ Pension Plan Board (OTPPB) played host to 350 of its portfolio companies at a conference in Toronto, and it had a consistent message key to protecting the pensions of its 350,000 members: “We see building resilience very much as part of our fiduciary imperative,” said Anna Murray, OTPPB senior managing director and global head of sustainable investing.
This goes for its teams that handle deal evaluation as well as portfolio management, Ms. Murray said.
As an example, the retirement plan and one of its partners worked with Jasper Farms, an Australian-based avocado grower that OTPPB acquired in 2017, to evaluate the impact of heat stress on the crops and implement adaptation methods such as more irrigation, shading, cooling fans and protection of pollinating insects and birds.
“For Teachers’ it’s not optional – if we want to continue delivering secure pensions, we have to integrate physical risks into how we invest and manage assets today,” she said.
