A failed global transition to a low-carbon economy could slash pension fund returns by as much as 33 per cent in the next 25 years, according to new modeling by Ortec Finance.

In the face of rising physical and transition risks tied to climate change, Ortec Finance’s managing director of climate scenarios and sustainability, Maurits van Joolingen, says the modeling captures the profound uncertainty surrounding climate change, from technology deployment to geopolitical responses, but the risks to long-term portfolio performance are no longer abstract.

“Climate change will definitely have an impact on the returns and the ability of pension plans to get their returns in the decades to come. But the extent is still uncertain,” says van Joolingen. “I think if we look at the net zero scenario… that’s becoming less likely to occur. The target is rapidly getting out of reach. I think the head of the United Nations last week mentioned it’s no longer possible. If it’s going to be the failed transition, we need to take some measures in defining the expected return for decades to come. But we shouldn’t be too pessimistic. There’s still a lot of opportunities to do things the right way.”

Still, van Joolingen is skeptical of the recent wave of institutions pulling out of net-zero alliances, including pension funds, consultants, and asset managers. While some view this as backtracking, he suggests it may reflect the sheer difficulty of the issue rather than a lack of commitment.

“They don’t want to be forced into a position where they need to give the answer on how they’re going to solve this issue,” he says, adding that many are still working on climate strategies behind the scenes.

He notes that the political sensitivity surrounding climate action may also be prompting institutions to step back publicly, even while pursuing transition goals internally. Despite this retreat from formal pledges, “I still hear pretty ambitious plans, even from those funds that stepped out of these alliances, to try and incorporate climate change into their investment operations,” he says.

Van Joolingen insists that the financial sector cannot drive the transition alone. Government policy and political support are essential to enabling structural change. He also calls for greater transparency around climate assumptions and modeling. By aligning around a core set of academically grounded assumptions, he believes stakeholders can “at least give everybody a more level playing field” when assessing climate risk.

While van Joolingen sees a shift in how pension funds are approaching climate risk – like moving away from blanket divestment policies toward more nuanced strategies – he urges pension trustees to shift focus toward strategic discussions about climate risks, timeframes, and mitigation actions rather than defaulting to pessimistic modeling.

The implications for geographic investment strategies are significant. While some regions, such as parts of North America and Oceania, may face outsized physical risks, van Joolingen resists the idea of wholesale regional divestment. And yet, despite many plans who initially adopted exclusions to decarbonize portfolios, he notes that approach is now being reconsidered.

“Paper decarbonization does not lead to a world with less climate change,” he says, underscoring that it’s better to identify resilient companies within exposed sectors and geographies, those with credible and funded transition plans.

“If you get your hands dirty and really start digging into specific corporate exposures, there’s still a lot of value to be gained,” he adds, encouraging investors to differentiate between high-emitting companies with no credible transition plan and those actively seeking capital to decarbonize -where both financial upside and climate impact can align.

Instead of avoidance, Doruk Onal underscored that climate risk is systemic.

“Even if you move your equity portfolio from Southern Europe to Canada, Canadian companies are still doing business with Southern Europe,” says Onal, climate risk consultant at Ortec Finance.

That means no portfolio is isolated. Instead, Onal argues for a deeper analysis of holdings, emphasizing opportunities in companies that are adapting or transitioning.

Ortec Finance’s climate scenario modeling builds on traditional economic frameworks by layering in both transition and physical climate risks. Onal pointed to their collaboration with Cambridge Econometrics, which provides macroeconomic modeling to assess how various climate pathways could reshape global economic performance.

He adds that Ortec captures physical climate risks in two distinct ways: the gradual impacts of rising average temperatures, affecting factors like labour and agricultural productivity and the more acute risks from extreme weather events like hurricanes, typhoons, droughts and wildfires. These are modeled at a granular, city-by-city level before being aggregated at the country and regional level.

Van Joolingen says the result is not a fundamentally new approach, but rather a sophisticated enhancement of Ortec’s core economic scenario generation capabilities.

“We can take into account those GDP impacts and translate them [into] what they mean in terms of financial returns,” he explains, noting that climate effects are integrated as extensions of the firm’s existing economic modeling framework.

Courtesy of Ortec Finance

Still, Ortec believes most pension funds have yet to fully grapple with how climate risk should be priced into their portfolios, largely due to the complexity and uncertainty of the issue as well as number of interconnected factors, like climate science and policy to economic modeling, that make climate pricing exceptionally difficult.

While he expects the process of integrating climate risk into asset pricing will be gradual, van Joolingen urges pension plans to start with a clear-eyed internal dialogue around assumptions. He has been critical of widely used frameworks like the NGFS scenarios, which he says rely on “unrealistic physical risk damage functions.” Getting investment teams to challenge those assumptions and engage in unbiased discussions, he argues, is a necessary first step.

“A world where we go through transition is a better world than a world where we go into high warming,” he says. “Once we all agree on that message, then we can hopefully motivate not only the finance people, but society in general that it’s time to make the transition happen.”

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