Investors Confront Rising Climate Risks in Asset Management Strategies

Extreme weather events are prompting major investors to reevaluate their strategies for managing physical climate risks. The Dryden Creek Wildfire, which occurred on June 11, 2024, near Squamish, B.C., exemplifies the urgent challenges faced by investment portfolios across the globe. Investors are now grappling with how to effectively assess and respond to threats posed by storms, floods, wildfires, heatwaves, and droughts.

While climate-related risks have long been recognized, the focus has predominantly been on emissions reduction costs and regulatory impacts. Increasingly destructive weather patterns are shifting the narrative, compelling sovereign wealth funds, pension funds, and other financial institutions to protect their assets and mitigate long-term damage.

Richard Manley, the Chief Sustainability Officer at the Canada Pension Plan Investment Board (CPPIB), which manages $732 billion in assets, stated, “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.”

According to CPPIB’s recent report, losses from storms, floods, and fires reached a staggering US$400 billion globally in 2024. Europe and Asia experienced significant damage to forests, electric systems, agriculture, and public health. In Canada, wildfires in regions including Manitoba and Nova Scotia caused extensive structural damage and adversely affected public health due to widespread smoke.

The response from the insurance industry has been to raise premiums, tighten policy terms, and, in some cases, withdraw coverage altogether. This reaction signals unaddressed exposure to climate risks, according to CPPIB. Furthermore, political fluctuations and the rise of populist leaders have led to a regression in climate targets, with Europe pausing certain sustainability reporting initiatives. Some clean energy resources are now being directed to meet the booming demand from data centers, rather than displacing fossil fuels in electricity grids.

The United Nations warns that current policies could lead to a global temperature rise of 3.1 degrees Celsius by the end of the century. Climate models have often underestimated the irreversible effects of global warming, such as chronic heat impacts on productivity and agricultural yields, along with the increased frequency and intensity of storms damaging infrastructure. Manley emphasized, “There is already potentially quite considerable physical risk baked into the economy by the middle of the century and beyond.”

Investors Adapt to New Realities

Investors are adopting various approaches to navigate these challenges. Jennifer Coulson, the Senior Managing Director and Global Head of ESG at the British Columbia Investment Management Corp. (BCI), noted that physical risk assessment encompasses both macro and micro considerations. “We have to be aware of the broad trends and what’s happening… physical climate-change risk is captured in the climate change scenario work that we do at the total portfolio level,” she said.

Acquiring relevant data and effective analysis tools remains a significant challenge as BCI prepares for diverse scenarios. In its latest Stewardship Report, BCI identified physical and transition risks as a priority in engagements with portfolio companies, emphasizing their potential threat to asset value, operational costs, and supply chains.

Many funds are refining their investment processes and incorporating climate-adjusted financial modeling into their due diligence. The CPPIB report highlighted that funds are utilizing a variety of technologies, regulatory engagement strategies, and external data experts to enhance their risk assessments.

Engagement with corporate boards and management teams has surfaced as a crucial strategy, with some funds prepared to withhold support for directors who fail to address climate risks. One tool CPPIB employs is Climate Value at Risk, developed by financial research provider MSCI. This metric estimates potential impacts on companies by modeling future costs and revenues influenced by policy and physical risks. It projects future scenarios to 2050 for transition risks and 2100 for physical risks.

In a recent conference hosted by the Ontario Teachers’ Pension Plan Board (OTPPB) in Toronto, the message was clear: building resilience is integral to protecting the pensions of its 350,000 members. Anna Murray, OTPPB’s Senior Managing Director and Global Head of Sustainable Investing, stated, “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.”

As an example of proactive adaptation, OTPPB collaborated with Jasper Farms, an Australian avocado grower it acquired in 2017, to assess heat stress impacts on crops. Adaptation strategies included enhanced irrigation, shading, cooling fans, and safeguarding pollinators.

The integration of physical climate risks into investment strategies is no longer a consideration but a necessity for asset managers aiming to safeguard their holdings in an increasingly uncertain climate landscape.