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North American pension funds could see returns decimated by 50 per cent if worst case scenario climate change forecasts materialise by 2040, industry research reveals.
A survey from Ortec Finance covering 140 pension funds worldwide, reveals pension funds based in the US and Canada are more at risk of poor performance than their European counterparts under a high warming scenario “if the current approach to setting and governing climate policy doesn’t change”.
The research finds that US pension funds are predicted to fare worst from increasing carbon emissions with investment returns diminishing by 50 per cent by 2040, followed by further declines without recovery until at least 2050.
Meanwhile, UK pension funds are likely to perform comparatively better, potentially incurring investment return drops of under 30 per cent by 2040 and reaching 30 per cent by 2050.
Doruk Onal, climate risk specialist at Ortec Finance, says the UK’s resilience is partly due to higher levels of asset diversification compared to the US, where pension funds have a heavy reliance on equities with allocations of 43.8 per cent.
The risk is particularly acute for US pension funds with significant exposure to fossil fuel companies which may become obsolete as economies transition to green energy sources.
Onal says: “Transition risks are expected to be the dominant climate risk driver compared to physical risks during the 2025–2030 period for pension funds worldwide. Additional low-carbon policies, revised NDCs (Nationally Defined Contributions), and net-zero target reviews by global investor alliance groups may accelerate the stranding of fossil fuel assets, potentially triggering market overreactions and widespread disruption.”
The research finds “significant variances” in how disruptive climate policies and transition risks will impact investment returns across pension systems in different regions. Certain UK pension funds are at risk of facing a decline in investment returns exceeding 20 per cent, while some US pension funds could see returns drop by 15 per cent in the short term.
Onal says “These potential declines are driven by the cascading effects of incoming climate policies, including market overreactions and sentiment shocks triggered by the mass sell-off of carbon-intensive assets. Such reactions could lead to liquidity challenges and abrupt price fluctuations as markets adjust asset valuations.”
In contrast, pension funds in Canada, the Netherlands and Switzerland show more homogeneous impacts from disruptive climate policies and transition risks.
Onal says a key reason could be a more stable and consistent policy environment in these countries, where clearer government action plans for transitioning to a low-carbon economy help reduce uncertainty for investors.
Onal adds: “The alignment between government policies and pension fund strategies is essential for pension systems and allows for a smoother adjustment to transition risks, minimising market shocks and promoting more uniform impacts on returns.”
The decline in investment returns has serious and far-reach implications, Onal warns.
“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.”