Investing in a changing world: How public funds are addressing climate-related physical risks

 A Turning Point: Why Physical Risk Now Demands Investor Attention

Stalling momentum on the climate transition is drawing greater investor attention to physical risk

For much of the past decade, investors had ample reason to prioritize transition risk. A clear policy environment and strong market signals—anchored by the Paris Agreement and reinforced at COP26—made it rational to assume that asset values would be reshaped by ambitious emissions-reduction strategies and a goal to limit warming to 1.5°C (2.7°F). This global agreement, along with forward-looking national and corporate commitments, suggested the financial impact of transition risk would materialize sooner, and more sharply, than physical risk.

That thesis has weakened. In the last year, populist victories in some of the world’s largest economies have installed leaders with regressive climate agendas. Indeed, the United Nations’ latest Emissions Gap Report projects that current policies could lead to 3.1°C (5.58°F) of warming by century’s end. The European Union has paused new sustainability reporting and European carbon prices remain well below recent highs. Corporate delivery has also stalled, with much of the demand for green energy now powering data centres instead of fossil fuels.

Meanwhile, physical climate impacts—wildfires, floods, and storms—have only grown costlier and more frequent. Losses topped US$400 billion in 2024, with damage from flooding and wildfires reaching new levels. Greece experienced its most intense wildfire season on record, and extreme heat across South Asia triggered power outages, crop failures, and widespread health impacts. These events are proving more severe and widespread than anticipated, prompting investors to reassess whether physical risk will materialize sooner—and with greater intensity and persistence—than previously expected.

As damages rise, insurance markets are responding—raising premiums, tightening terms, and in some cases, withdrawing coverage. For investors, this shift is more than a cost consideration; it’s an early market signal of unaddressed exposure. Assets that lack adequate adaptation measures will become increasingly difficult to insure. Conversely, forward pricing for insurance (if it were more readily available) could help put a dollar value on physical risk and the benefits of investing in resilience—showing how protective measures today can insulate business from future cost increases and help preserve long-term asset value. Crucially, while insurance can signal and transfer financial risk, it does not reduce the underlying physical vulnerability—true resilience depends on the asset’s ability to withstand climate-related impacts.

Put simply, few underwriting challenges facing investors today are evolving as rapidly—or with greater consequence.

This paper outlines how five leading public investment funds—defined here as long-term, government-backed institutional investors, including public pension funds and sovereign wealth funds—are beginning to integrate physical risk into their investment processes. These funds, collectively managing approximately USD$2.7 trillion in assets, shared insights on the various barriers they face, the data they currently use, and the lessons they’ve learned. The result is an early, consolidated view of emerging approaches to physical risk integration—not a single case study, but an amalgamated perspective on what will be required to better mitigate risk.

To be clear, this paper represents a snapshot in time. Investors’ understanding of the portfolio implications of physical risk is advancing quickly, as are the techniques and technologies for managing it. Five years from now, the approaches of these institutions will likely look very different.

Nevertheless, for investors, an understanding of where things stand today is an essential first step toward building more resilient investment strategies. For companies, the same insights can serve as a market signal—clarifying what’s required to enhance long-term investability and attract capital. More broadly, improving how physical risk is understood and managed can enhance the whole investing ecosystem—enabling better capital allocation, more informed engagement, and stronger long-term outcomes for all market participants.

‘At least in the sustainability space, it is reasonable to assume that most of the innovation in financial markets over the next decade will be in the underwriting and pricing of physical risk. Unlike other sustainability factors that have proven harder to quantify, physical risk and its mitigation will translate directly into security prices through insurance costs or the direct impairment of asset values.’ Richard Manley, Chief Investment Officer, CPP Investments

Defining physical risk

The public funds we spoke to defined physical risk as the potential for financial loss due to climate-related events. It can be divided into two categories: chronic risks, which develop gradually over time (such as rising sea levels or increasing temperatures), and acute risks, which result from extreme weather events like floods, wildfires, or hurricanes. Physical risks are recognised as a certainty, meaning they are expected to occur regardless of the specific climate situation and will manifest even in a warming scenario of 1.5°C (2.7°F).[i] The Potsdam Institute for Climate Impact Research found that even with drastic cuts to CO2 emissions starting today, the world economy is already set to experience a 19% income reduction by 2050 due to climate change.[1][ii] The question is not if physical risks will manifest, but when, to what extent, and how frequently.

One fund highlighted that exposure to chronic risks is most significant from a top-down, strategic asset allocation perspective, emphasising ‘the failure of financial markets to adequately price the systemic, chronic risks associated with long-term climate change’. These can include, but aren’t limited to, large-scale climate migration and sequential crop failures. Exposure to acute physical risks is most severe in real estate and infrastructure—core components of real assets. But it also extends across the portfolio, affecting a range of asset classes including listed equities and bonds.

The long-term nature of investments held by these public funds amplifies the exposure to both acute and chronic risks, particularly in infrastructure assets where damages can directly affect cash flows and asset values. In addition, physical risks can affect supply chains and broader macroeconomic conditions, , which indirectly impacts asset prices.

Assessment methods and frameworks

Public funds employ a variety of methods to assess physical risks, blending top-down macroeconomic analysis with bottom-up asset-level evaluations. One common approach among the funds interviewed is the use of scenario analysis to understand potential impacts and asset exposure under different climate trajectories. Climate scenario analysis is used to assess the impact of macroeconomic shifts on the portfolio, examining GDP and inflation impacts through models such as the National Institute Global Economic Model (NiGEM) transition scenario outputs, the Network for Greening the Financial System (NGFS) scenarios or the MSCI Climate Value-at-Risk framework.

Funds are trialling approaches to support early screening for risk in deals ‘to better incorporate the financial implications in base case underwriting, and to conduct deeper assessments of indirect risk’. These include high-resolution damage functions, or models that provide estimations of damage caused by various factors, including extreme weather events, to specific assets. These account for asset characteristics such as age, material, and location, as well as external risks such as supply chain disruptions. Many public funds also collaborate with external providers to refine their risk models.

Despite this, ensuring the accuracy of these models remains a key challenge. Most models struggle to translate changes in the frequency and severity of climate events to a monetary damage value. As a result, public funds acknowledge that, while models help identify key risk concentrations, they cannot yet provide precise predictions of financial impact.

In addition, one fund noted that physical risks are currently underestimated and not priced correctly in the market. ‘We’re finding a 2% loss in the equity portfolio in 2080 with this approach and that’s just not realistic.’ The fund is therefore conducting its own ‘top-down’ approach, examining the impact of climate on GDP and economies and how companies are exposed. This has revealed a ‘19% loss on equity portfolio in the U.S. compared to 2%’. Nevertheless, the fund acknowledged ‘we’re still underestimating the tipping points, chronic damages and migration’. Notably, the underlying assumption in models is that insurance market capacity will expand to meet rising demand for risk transfer. However, a material repricing of insurance premiums to reflect increasing probability of damage—or a loss of access to coverage altogether—could cause physical climate risks to be priced into securities well before actual losses materialize. Moreover, current models often underweight cascading impacts such as climate-driven migration and the potential for associated political or economic instability.

Barriers to integration

A primary challenge in integrating risk is data availability and robustness, especially for assets where location-specific data are often limited (Figure 1). Many models struggle with accurately capturing the financial materiality of assets, especially in regions or sectors where risks are poorly understood or underpriced.

Current market practice largely relies on climate scenarios and integrated assessment models that are ‘inherently uncertain, particularly on multi-decade timespans with potential tipping points and second- or third-order downstream impacts.’ One fund noted there is an inherent ‘tension in applying a number of scenarios to produce a range of results.’ This provides a broad perspective but is challenging to use in practice. Alternatively, a base-case scenario is easier but risks ‘building a narrow focus when managing the climate risks of the portfolio’.

One fund observed that the NGFS uses quite narrow and linear scenarios, with outdated socioeconomic patterns. This means they represent ‘a very co-operative world’ that only reflects changes in climate and is therefore not necessarily accurate when it comes to broader risk factors.

While catastrophe risk models offer a potential solution, they are often constrained by political sensitivities and tend to understate physical risks. This issue is particularly prevalent in stress-testing models used by central banks, which tend to underestimate the full impact of climate-related physical risks.

Another barrier is the misalignment between the time horizons of physical risks and investment cycles. Physical risks typically manifest over long periods and, as one fund highlighted, ‘traditional valuation techniques are more likely to price in near-term policy risk but underestimate the cost of long-term physical risk.’ This mispricing contributes to long-term systemic risk in the market and makes it difficult to fully incorporate long-term physical risks into investment decisions, even though private market investments, such as infrastructure, are less affected due to their longer time horizons.

Finally, one fund said adaptation, metrics, assessments, plans, and investments are ‘lagging in terms of policy development, feasibility, budget, and investment case, yet are an important element of physical risk assessment.’

Mitigation strategies

To overcome these challenges, funds are expanding their analysis of physical risks, particularly for listed equities and corporate bonds, despite the limitations in data. Some funds are investing in new geospatial and satellite-based climate risk analytics to improve the granularity of location-specific risk assessments. Others are integrating catastrophe modelling frameworks to refine their predictions of extreme weather events and their financial impacts. A fund from Asia Pacific said, ‘We are actively trialling catastrophe risk models to bridge the gap in severity forecasting and better quantify asset-level exposures.’

Collaboration with industry bodies such as the NGFS and the International Energy Agency has become a key strategy for improving methodological frameworks and regulatory alignment. Some funds are also engaging more directly with data providers and research institutions to advocate for improved climate datasets, ensuring they capture both direct asset vulnerabilities and indirect supply chain risks.

Many public funds are refining their internal investment processes and incorporating climate-adjusted financial modelling into their due diligence. One North American fund stated, ‘We are working to integrate physical climate risk metrics into our base case underwriting to ensure that assets are priced correctly in consideration of long-term exposure.’ Additionally, some funds are building internal climate risk teams to monitor evolving regulatory requirements and ensure that investment strategies align with the need for climate stress tests imposed by financial regulators.

Despite these challenges, funds are increasingly leveraging technology, regulatory engagement, and enhanced data partnerships to bridge gaps in risk assessment. While current methods are not yet perfect, these mitigation strategies mark a significant step toward embedding physical risk into investment decision-making.

Engagement with investee companies and stakeholders

Engagement with investee companies is a crucial strategy for addressing physical risks, with investors adopting a range of approaches to ensure that climate risks are properly considered. Some funds prioritise high-risk assets and sectors for closer scrutiny, working directly with private equity partners and real estate managers to implement adaptation measures such as flood protection and infrastructure reinforcement. One North American fund explained, ‘We identify priority investee companies for more frequent engagement and monitoring, discussing key physical risks and company-level risk management processes.’

In addition to direct engagement, some funds collaborate with engineering firms and climate specialists to assess the physical resilience of their holdings. Others rely on engagement and voting strategies to push for greater climate disclosure and risk management practices. A fund from Asia Pacific noted, ‘We are beginning to assess facility-level data to identify vulnerabilities and improve engagement strategies with investee companies.’

While engagement is more straightforward in private markets, investors managing large, diversified public portfolios are integrating facility-level data into risk assessments and using conditional value-at-risk models to measure exposure.

Value creation opportunities in physical risk resilience

Beyond risk mitigation, improving resilience presents material value-creation opportunities. Some funds see adaptation solutions as an investment opportunity, with climate resilience-focused sectors such as flood protection infrastructure, wildfire-resistant real estate, and coastal defence systems becoming increasingly attractive. One fund noted that ‘Investing in adaptation measures, such as seawalls through public infrastructure programmes, can provide resilience while also delivering financial returns.’

Investors who proactively assess and manage physical risk may also gain a competitive advantage by identifying companies better positioned for long-term sustainability. One Asia Pacific fund explained, ‘Assessing physical risk preparedness allows us to identify companies better positioned for long-term sustainability, reducing exposure to stranded assets.’ Strong physical risk management can provide benefits in terms of insurance and financing, with companies that have clear adaptation strategies often securing better insurance terms. Additionally, forward-looking insurance pricing for currently unaddressed physical risks could serve as a valuable economic signal—highlighting how adaptation investments can reduce future insurance costs and framing their benefit through the lens of avoided cost increases. A North American fund pointed out, ‘We see value creation in reducing vulnerability to physical risk, which can translate to better cash flows going forward.’

Conclusion

While the impact of physical risk is recognised across various asset classes, its integration into investment decisions remains a work in progress. With improved models and data and greater collaboration, public and private funds are better equipped to understand and mitigate the financial impacts of climate change. However, there remains a need for continuous development in both methodology and data availability to fully address the physical risks posed by an evolving climate.

A growing number of funds are demonstrating leadership by integrating today’s advanced climate risk analytics, refining engagement strategies with investee companies, and advocating for industry-wide improvements in data collection and transparency. These efforts will be critical in ensuring that physical risks are not just understood but proactively managed to protect long-term portfolio resilience. Far from being contained to individual securities, unmitigated physical risk at the asset level has the potential to become a systemic rather than an idiosyncratic risk. This is due to its ability to impact critical infrastructure and value chains and its potential transmission through asset prices via insurance markets affecting earnings, coverage ratios, collateral value, and covenants. While decarbonizing the real economy remains essential to avoiding the worst impacts of climate change, it is increasingly clear that greater resources must also be devoted to understanding, mitigating, and accurately pricing physical climate risk.

Looking ahead, investors that embed climate risk considerations into their core investment frameworks will likely be better positioned to navigate an increasingly uncertain future, capturing opportunities that arise from improved resilience while mitigating downside risks. Moreover, by surfacing the emerging practices cited in this paper, we hope to support a broader market shift—where better climate risk management becomes a driver of resilience, value creation, and ultimately, stronger returns for long-horizon investors and their beneficiaries.

Key quotes

‘Data granularity, especially at the asset level, is a major hurdle. We’re often operating with incomplete or inconsistent inputs.’

‘Traditional valuation techniques fail to account for long-term physical risk. This creates a structural blind spot.’

‘We use a base-case scenario out of practicality, but it narrows our risk lens significantly.’

‘Most models aren’t equipped to deal with compounding events, they’re still too linear.’

‘Adaptation remains underdeveloped and there’s no standardisation and limited incentives to fund these measures.’

Acknowledgements

We would like to thank the following individuals for their time and insight:

Richard Manley, Chief Sustainability Officer, CPP Investments

Anne-Maree O’Connor, Head of Sustainable Investment, New Zealand Superfund

Wong De Rui, Senior Vice President, Sustainability Office, GIC

Jack Virgin, Senior Associate, Sustainable Investing, Healthcare of Ontario Pension Plan

Eivind Fliflet, Head of Environmental Team, Active Ownership, Norges Bank Investment Management

About OMFIF

With a presence in London, Washington and New York, OMFIF is an independent forum for central banking, economic policy and public investment — a neutral platform for best practice in worldwide public private sector exchanges. omfif.org

Project team

Emma McGarthy, Head, Sustainable Policy Institute, OMFIF

Yara Aziz, Economist, Economic and Monetary Policy Institute, OMFIF

Sarah Moloney, Chief Subeditor, OMFIF

Ophelia Mather, Marketing Coordinator, OMFIF

About CPP Investments Insights Institute

The CPP Investments Insights Institute delivers actionable insights on the most pressing challenges facing long-term investors. Drawing on CPP Investments’ global expertise, the Institute partners with business leaders, academics, and leading think tanks to publish high-impact research. It also leverages its convening power to spark conversations that shape strategy, advance investing excellence, and drive long-term value—for the Fund and the broader investing ecosystem.

cppinvestments.com/insights-institute

Contributors:

Maria Montero, Managing Director, Office of the Chief Sustainability Officer

Glenn Sim, Associate, Portfolio Value Creation

Jamy Kallikaden, Managing Director, Sustainable Design, Total Fund Management

Endnotes

1. Scenarios Portal, Network for Greening the Financial System. Accessed May 2025.
2. Kotz, Maximilian et al. The economic commitment of climate change. Nature, April 2024.

[1]

[i] https://www.ngfs.net/ngfs-scenarios-portal/about

[ii] The economic commitment of climate change | Nature