For much of the past decade, investors had ample reason to prioritise transition risk. A clear policy environment and strong market signals 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° Celsius. This global agreement, along with forward-looking national and corporate commitments, suggested the financial impact of transition risk would materialise 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. 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 retiring fossil fuels.
Meanwhile, physical climate impacts – wildfires, floods and storms – have only grown costlier and more frequent. Losses topped $400bn in 2024, with damage from flooding and wildfires reaching new levels. These events are proving more severe and widespread than anticipated, prompting investors to reassess whether physical risk will materialise 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.
A new report by CPP Investments Institute and OMFIF outlines how five leading public investment funds are beginning to integrate physical risk into their investment processes. These funds, collectively managing approximately $2.7tn 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.
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.
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.
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 decarbonising 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.
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.
Looking ahead, investors that embed climate risk considerations into their core investment frameworks will be better positioned to navigate an increasingly uncertain future, capturing opportunities that arise from improved resilience while mitigating downside risks.
Download ‘Investing in changing world‘, published by OMFIF and CPP Investments Institute.
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