Physical risk as a result of rising temperatures is the most serious threat to asset performance, Ortec Finance has said, after its research showed that even most ambitious scenario does not anticipate the world reaching net zero until mid-2050.

Ortec Finance's updated 2025 climate scenarios highlighted several important areas of developing risk for institutional investors, noting that the medium to long-term impact of physical risk is far more pronounced in the scenarios that incorporate last year’s 0.2°C temperature spike and simulate the outcomes of the world’s current climate policies.

“Following the warmest year on record, the Paris Climate agreement target of limiting global temperature rises to 1.5°C by the turn of the century looks increasingly unlikely,” Ortec Finance managing director, climate scenarios and sustainability, Maurits van Joolingen, said.

“Even our most ambitious scenario does not anticipate the world reaching net zero until mid-2050 and shows temperatures rising to by 1.6°C by 2100.”

Ortec explained that this increased physical risk will also boost consumer price inflation, with its high warming scenario indicating that, by 2050, price levels will be 11 per cent higher in the US and 6 per cent higher in the UK in comparison to Ortec Finance’s baseline expectations.

In particular, Van Joolingen said that agricultural and labor productivity could suffer "significantly" as temperatures rise and long-term physical risk impacts increase, the combined effect of which could be highly inflationary to consumer prices.

This high warming scenario also assumed that the 2024 temperature spike will persist in the long term, further heightening chronic physical risk and negatively impacting GDP.

This, according to Van Joolingen, could see the average global real GDP growth in the next 25 years drop to 1.1 per cent - making it much harder for central banks to control inflation with monetary policy.

"This worsens in the following period up to 2070, where increasingly severe physical damage leads to almost zero real growth on average," he added.

In addition to this, the updated scenarios demonstrated how climate change could influence credit default rates during periods of market disruption, comparable to the global financial crisis and dotcom crises.

In particular, Ortec Finance found credit default rates show an initial uptick in investment-grade corporate bond defaults in 2030 under the delayed net-zero scenario, sparked by a sudden step-up in policy action.

However, under the high warming scenario, where there is a lack of sufficient policy action to limit climate change, the impact from 2038 onward becomes "far more severe", driven by the wider recognition of the scale of future climate risks.

Regional differences would be likely, as Ortec clarified that the implications for asset repricing across countries and sectors are closely tied to their exposure to both transition and physical climate risks.

In particular, Ortec Finance found that the high warming scenario would see equity asset performance in the UK and US decline sharply in the 2030s due to an emerging insurance crisis, driven by the manifestation and increasing awareness of physical risks associated with rising temperatures.

Furthermore, after a period of relative stability, equity prices are then expected to fall even more steeply in the late 2030s, driven by the impact of further escalating physical climate risks and insurers withdrawing from more markets.

Regional differences were not the only gap highlighted, as Ortec Finance showed that the gap in projected equity returns because of different sector exposures to transition risk has never been more pronounced.

However, it suggested that this could create opportunities for investors to realign portfolios to mitigate any fallout from the transition.

Van Joolingen said: “It is clear that under current policies, where there is hiatus in political willpower to reach net zero across large swathes of the developed world, temperatures will continue to break records.

"As a result, physical risk poses the greatest threat to institutional investment portfolios and the stability of the global financial system. The recent surge in global temperatures and corresponding risk of triggering a range of climate tipping points, accentuates the potential downside even further.

“Our latest release of scenarios are designed to help financial institutions fulfil their fiduciary duty to members and stakeholders by ensuring they fully understand climate change’s realistic impact across a broad range of potential outcomes and periods of market disruption.

"It also equips them with the tools to help mitigate the impact of climate change on their portfolios and identify opportunities for investing towards the low-carbon economy.”

Pension funds in the UK have faced growing scrutiny over the climate scenarios being used in their investment decisions, with British Business Bank chief investment officer, Leandros Kalisperas, recently admitting that current climate risk assessments on pension investments “may not be credible".

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