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August 9, 2023

Pension funds should reject conventional finance theory in push for net zero, says University of Exeter

Towards net zero:  Some observers have criticised the weaknesses of the official climate scenarios used by financial institutions (Photo: Nathan Laine/Bloomberg)
Towards net zero: Some observers have criticised the weaknesses of the official climate scenarios used by financial institutions (Photo: Nathan Laine/Bloomberg)

UK pension funds are being encouraged to rethink their approach to risk as research notes climate scenarios are not currently considered ‘decision-useful’.

A new report from the University of Exeter says pension funds in the UK should move away from net zero approaches that rely on modern portfolio theory, and adapt their investment strategies in the fight against climate change.

The paper says that “official climate scenarios are increasingly regarded as not being ‘decision-useful’” and advocates the use of climate scenarios that employ “real-world narratives” to assess future investment risks. This includes considering “all the potential effects of a policy that might be important, even if a financial value cannot be applied to it”, the study says. 

The report lands amid uncertainty over the accuracy of models that the UK pensions market uses to assess climate change. Following reports that some scenarios may underestimate the financial risks of climate change, in August The Pensions Regulator urged UK pension trustees to address shortfalls in data and modelling found in their climate analysis. 

Mike Clark, fellow of the Institute and Faculty of Actuaries, says investors’ approaches are already beginning to change. “Leading pension funds and other asset owners are moving well beyond the constraints of standard finance theory. Further, they are starting to recognise the weaknesses of the official climate scenarios which fail to meet their pressing needs,” he says.

“Many funds are now seeking to align their assets to a halving of greenhouse gas emissions before the decade is out. Official scenarios offer next to no guidance on how to achieve that.”

Exeter is working with the Universities Superannuation Scheme on the development of its climate scenarios. The study says pension funds in other countries would also benefit from a new approach.

You can read the full report here.

A service from the Financial Times