Canadian pension funds could face a 44% hit to annual returns by 2050, according to a study of climate risk by Ortec Finance, a Rotterdam-based advisory.
“Canadian pension funds are expected to experience significant impact from both transition and physical climate risks,” said the report’s author, Doruk Onal, climate risk specialist.
Onal said that the Canadian funds’ exposure to equities and alternative investments puts them at risk “if climate policies remain unaddressed.” Canadian funds have 30% and 25% portfolio allocations to equities and alternatives, respectively, according to the report. A worst-case scenario, where the world continues to increase carbon emissions and temperatures rise 2 C by 2050 and nearly 4 C by 2100, could put future distributions to members at risk, Onal wrote. Canadian pension funds could see a 9% lower investment return by 2030 and 44% decline by 2050, according to the report.
“These declining returns could profoundly impact the financial stability of the pension fund, reduce future pensioners’ payouts, increase uncertainty for current employees relying on these funds for retirement security and add pressure on the sponsor to fulfill the pension obligations,” he wrote.
U.S. funds, which have a higher weighting in risky assets than their Canadian counterparts, could see returns cut by 50% as soon as 2040. U.K. funds face a possible 30% decline by 2050 in this high-warming scenario, according to the report.
Even if the world achieves net zero by 2050, accelerated decarbonization policies could trigger an extreme market overreaction and financial crisis, according to the report.
“If that shift happens in a quick and drastic way, that could leave what we call stranded assets,” Onal said. “The financial markets [could] react dramatically to that policy change and suddenly start to value the fossil fuel assets as basically zero.”
In this scenario, short-term transition risks would be most prominent, with a 15% near-term decline in investment performance followed by a moderate recovery.
Fiduciary duty
Canadian pension funds have faced criticism for lagging on climate commitments. As of 2023, two out of the largest 11 pension funds in Canada hadn’t yet set emissions reductions targets for 2050 or earlier – AIMCo and BCI. That’s according to a study released early last year by Shift Action for Pension Wealth and Planet Health, a non-profit organization that aims to pressure pensions on climate action. Its report estimated pensions hold at least $80 billion in fossil fuel investments, likely an underestimate because of a lack of disclosure. Shift said in an email that this year’s report will show little change in 2024 from the year before.
Even though pension funds constantly assess financial risks, many haven’t done climate assessments specifically, Onal said. That’s because climate risk is a relatively new domain within financial risk assessment, albeit one that’s growing quickly.
“Understanding climate risk is part of their fiduciary duty,” he said. “If you’re not taking into account what climate change could potentially do to your investments, then that kind of implies that you’re not doing your best for your future pensioners.”
Ortec used publicly available data to conduct aggregate assessments of the top 30 pension funds in Canada, the U.S., U.K., Switzerland and the Netherlands. It employed top-down modelling, which means it modelled the impact of changing climate on the global economy, then how those changes may impact different sectors, regions or investment types.