With gaps and vulnerabilities appearing across portfolios, institutional investors are having to re-think their approach to protecting long-term returns from physical climate risks (part one of two).
Last month, the World Meteorological Organization’s (WMO) latest State of the Global Climate report confirmed that climate change is accelerating. Global temperatures, energy imbalances and ocean heat absorption have consistently set new records over the past 11 years, it noted.
The rate of ocean warming over the past two decades is more than twice that observed over the period 1960–2005. This increases the risk of marine ecosystem degradation and reduces the ocean’s capacity to act as a carbon sink, fuelling tropical and subtropical storms and sea-level rises.
“When history repeats itself 11 times, it is no longer a coincidence. It is a call to act,” said UN Secretary-General António Guterres.
Estimates of annual economic losses from extreme weather and physical impacts of climate change vary around US$200-300 billion, with Munich Re recently reporting US$224 billion lost to natural disasters in 2025, of which US$108 billion was covered by insurers.
For the asset owner, this information is alarming, but unactionable. The task of translating headline hazards into financial impacts at the asset or portfolio level is next to impossible, due to limited data and disclosures, inadequate scenarios and analytics, and weak political will.
The lack of strategic vision or granular information from investee companies leaves asset owners chasing shadows when they should be building portfolio resilience to protect long-term returns.
“Outside of infrastructure and perhaps real estate, we’re really struggling to get traction on this issue,” says Faith Ward, Chief Responsible Investment Officer at Brunel Pension Partnership, a UK-based public pension fund with £35 billion (US$46.19 billion) AUM.
Lack of depth
While many large firms provide high-level information on their exposures to the physical risks of climate change, disclosures barely scratch the surface of operational impacts or financial costs.
Around 80% of the 3,000 publicly listed companies captured in the Bloomberg World Index mention their exposure to physical risks in their annual sustainability or financial report.
“If we go a level deeper, to see what they’re saying about what those exposures amount to, the reporting quickly becomes a lot more scarce and less standardised,” says Edo Schets, Head of Climate, Nature and Sustainability Regulation Solutions at data provider Bloomberg.
Even if they’re operating in the same sector, he adds, it can be extremely difficult to compare the exposures of two companies. It’s harder to still to find out what firms are doing about them or how much their spending.
Bloomberg estimates around 30-50% of firms are reporting on their adaptation and resilience strategies, varying by geography. And less than 1% disclose on capital expenditure toward adaptation and resilience, despite specific requirements under the Corporate Sustainability Reporting Directive (CSRD) or the standards of the International Sustainability Standards Board (ISSB).
One of the reasons for weak information flows is difficulty isolating expenditure on adaptation from existing costs, on refurbishment, maintenance or staffing.
“In real estate, for example, adaptation components might account for 5-10% of refurbishment costs. But they’re typically not separated out; installation of, say, triple glazing is not just driven by adaptation to higher temperatures,” says Udo Riese, Global Head of Sustainable Investment at Allianz Investment Management (Allianz IM).
Many investors blame the paucity of decision-useful information on the implementation of disclosure requirements from the Task Force for Climate-related Financial Information (TCFD). While the TCFD framework asks for detailed information on adaptation strategies, the overall result has been too much focus on high-level hazard and risk quantification, and too little on outlining either a coherent strategy or operational impacts and costs.
“A lot of corporates have done TCFD reporting using top-down rather than bottom-up analysis, which is why the information given to an asset owner is diluted, lacking the level of granularity needed to pick out where exposures really sit,” says Kimberly Ong, Director, Client Solutions & Engagement Lead at insurance group Howden’s climate risk and resilience advisory unit.
“We’re starting to see a bit of a correction, because firms are being asked questions, and can’t say where they’re going to implement adaptation and resiliency measures,” she adds, drawing a distinction between real asset and listed portfolios, with components of the latter often failing to provide a “look through” to investors on account of size and geographic spread.
Chronic and cascading risks
While gaps and vulnerabilities vary across portfolios, frequent shortcomings include second order and supply chain impacts, over-reliance on insurance availability, and a focus on acute risks at the expense of chronic ones.
“There’s a tendency to deal with the risks with which we’re familiar – the acute risks like storms and floods. But it’s harder to deal with the second order or the chronic risks. It’s not the heat waves that are the problem, but the persistent increase in temperature. The impacts can be less obvious. And typically, we don’t have the experience to deal with them,” says Riaan Potgieter, Investment Director at StepStone Group, which specialises in private markets solutions and advisory services.
Chronic risks can have major implications for asset maintenance costs and replacement schedules, as well as shift patterns and staff costs, feeding through to budgets, cash flows and ultimately asset valuations. And too much focus on the initial damage costs potentially means ignoring more significant business interruption impacts that might arise from loss of access or reduced footfall.
“It’s the cascading risks people don’t often understand,” says Rob Gardner, CEO of Rebalance Earth, a natural capital-focused asset manager.
“Over and above whether my factory floods, it matters more if I can’t get my goods and services into the factory, if my staff can’t come to work, or if there’s no power to the factory. If it’s happening as a one-off, I can get insurance, but if it’s on a frequent and systemic basis, I need to fund that adaptation.”
When looking to build resilient and diversified portfolios, the critical insight for asset owners is whether and how physical risks are being managed.
“It’s not about the numbers,” says Ward, also Chair of the Institutional Investors Group on Climate Change (IIGCC).
“It’s about controls, systems, processes and governance. We want to know how the asset manager is doing the due diligence: what has been evaluated, what models are being used, and what mitigating action or adaptation approach has been put in place.”
Residual risks
To fill in the gaps and bolster their defences against physical risks, asset owners are upgrading their own tool and skillsets, leveraging stewardship channels and sending clearer signals via capital allocation decisions. But they’re also aware of the need to go beyond existing paradigms.
As part of its efforts to better integrate physical climate risks into its investment decision-making, Brunel has deployed a three-step framework developed in partnership with StepStone across its private markets holdings.
The first stage covers the due diligence needed to understand a general partner’s (GP) approach to climate risk, including how they assess materiality, quality of adaptation plans, and how they incorporate adaptation into valuation. The second stage involves ongoing monitoring of progress, covering provision and updating of materiality assessments and resilience plans. The third element focuses on capturing the residual physical risks that cannot be addressed in isolation.
“It focuses attention on the risks that need engagement with other stakeholders, potentially including policymakers or other investors, because there are some risks you cannot mitigate by yourself,” says Potgieter.
The bears in mind the existing guidance frameworks from the IIGCC: the Climate Resilience Investment Framework (CRIF), which acts as a portfolio-level roadmap for asset owners; and the recently updated Physical Risk Appraisal Methodology (PCRAM 2.0), which provides an asset-level assessment methodology. StepStone has approached the IIGCC with a view to incorporating its approach into CRIF.
As they step up their efforts across portfolios, information-gathering remains a priority for asset owners, including ensuring adaptation is included in credible transition plans from listed equities, to help them identify and act on the most financially material risks.
Finalised in 2024, the Transition Plan Taskforce’s (TPT) disclosure framework called for firms to give equal consideration to adaptation and mitigation in transition plans, issuing a dedicated ‘primer’ to help firms assess physical risks, identify vulnerabilities and incorporate adaptation actions into business strategies.
Last year, the ISSB published voluntary transition planning guidance that builds on the work of the TPT and its own IFRS 2 climate reporting standard, recommending that plans cover adaptation to a climate-resilient economy across business models, assets, functions and supply chains.
But listed firms are not yet widely compelled to publish transition plans, with CSRD only requiring Europe firms to publish on a ‘comply-or-explain’ basis, and the UK still currently mulling whether to mandate them following a recent consultation.
Strategies and scenarios
Strategic clarity on adaptation will need to be augmented by operational granularity from portfolio companies. Leah Ramoutar, Director of Environmental Sustainability at Aviva, the insurance and investments group, says too much existing physical risk data is historical or high level.
“Rather than a regional flood map or a national heat map, investors increasingly will start needing more granular data, at a building, high street or town level,” she says.
Not only does this hazard data need to translate to valuation, impairment or stranded asset impacts, asset-level data should be standardised via data-sharing templates, enabling asset managers to prepare comparable reports for institutional investment clients, Ramoutar adds.
Critically, this information needs to be plugged into a framework that helps the asset owner prioritise action. This means stress testing portfolios against a variety of climate scenarios, despite the mixed past experiences of asset owners, where available models have often led to an underestimation of physical impacts.
While the latest scenarios of the Network for Greening the Financial System continue to attract criticism for underplaying the tipping points (new iterations are planned by end-2026), there are a range of options available to asset owners. Last year, UK-based asset owner the Universities Superannuation Scheme offered for peer use four scenarios developed for its own climate modelling, which sought to better reflect dynamics between financial markets, technology innovation and energy systems.
Developed in collaboration with the International Institute for Applied Systems Analysis and the Potsdam Institute for Climate Impact Research, the United Nations Environment Programme Finance Initiative recently released its Climate Pathways Navigator climate scenario tool. It provides access to multiple scenarios, including those assessed by the Intergovernmental Panel on Climate Change (IPCC) as well as granular sectoral and regional data points.
Last October, the UK’s Climate Change Committee recommended preparing for a 2°C climate by 2050 scenario, characterised by threats to public health, food security and widespread flooding risk
Howden’s Ong recommends that asset owners try to assess how their portfolios perform across a range of scenarios, before drilling down to the next level: assessing the resilience measures available to portfolio companies to manage physical risks, then modelling implementation cost and risk reduction impacts.
“Corporates are being pushed to show the cost/benefit of putting in place a measure to prevent a future impact. As such, using scenarios to model – and put a price on – those potential outcomes is key,” she says.
The nascent stage of adaptation and resilience-related information flows obliges asset owners and managers to exercise caution, however.
“Different vendors may use different climate models. They may be modeling things on a different time horizon. They may have a different definition of a hazard. You don’t need the same model for everyone, but you need common framing around it,” acknowledges Ramoutar.
Part two of this article explores how asset owners are going beyond stewardship and asset allocation to address adaptation and resilience risks in their portfolios, increasingly collaborating across the finance sector and demanding a more proactive approach from governments and regulators.
