Institutional Investors Generally  don´t mine coal, make cement or indiscriminately strip large forests. But the companies in which they invest might be engaged in such activities that experts say will prove incompatible with the shift to a lower-carbon world. And, they add, a retirement plan’s holdings of these at-risk investments could have negative consequences for plan participants.

Plan Exposures

Climate change risks can affect plans in several ways, says Therese Feng, vice president of research for The Climate Service, a climate risk analysis firm in Durham, North Carolina. Physical climate risks such as droughts, fires and rising sea levels can result in both market and credit losses in a portfolio. For example, imagine that drought conditions continue to worsen in California, which accounts for almost 15% of the U.S. economy. At some point, the lack of water and resulting rationing conceivably could constrict the state’s businesses, particularly agriculture, and reduce employment levels. The resulting slowdown to such an important component of the U.S. economy could then affect national business conditions and stock market values.

For corporate and government instruments, losses from physical damages and diminished asset values can lead to lower instrument values, increased return volatility and increased credit risk, Feng says. Instruments collateralized by physical assets, most notably mortgages, carry increased credit risk due to physical climate risk.

Investors also face climate transition risk, she adds. Transition risk is the potential financial impact of the economic transition to lower greenhouse gas emissions, which includes a shift to using lower-carbon energy sources and increased use of lower-emission technologies. To date, investors have focused more on transition risk than on physical risk due to access to data and methodology, says Feng. “But institutional investors need to be knowledgeable of how both physical and transition risks can affect their strategies, both in the near- and medium-term,” she cautions.

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