Strengthening Investment Policy Decisions: How Trustees Can Manage Climate Risk
Time and again, worker pension funds have been invested in ways that directly undermine the workers who contribute to them. Some of this behavior is attributable to fiduciary duty drift - chasing returns and short-term results pressures.
Realigning fiduciary duty with pension fund participants' and beneficiaries' actual economic interests is critically important for restoring worker confidence in their retirement funds and advancing worker interests in the 21st century. Whether by statute, interpretive letter, or investment policy reform, the time to act is now.
Pension funds typically own a wide variety of portfolio companies to diversify risks. However, even if a fund is well-diversified, it doesn't guarantee exemption from systemic risk, which can affect all portfolio holdings. One source of systemic risk is climate change. Climate change will eventually damage the planet enough to cause a decline in global economic activity, affecting the entire stock market. Another recognized systemic risk is economic inequality, and yet another is the threat to the rule of law. Both risks, like climate change, can significantly impact long-term financial stability. If your fiduciary can prudently protect your pension from these risks, they are obliged to do so. This obligation extends to addressing emerging systemic risks- such as climate change, which poses a significant threat to the stability of pension funds.
Trustees have a unique role in raising the need to properly manage climate risk in a pension fund's portfolio. This falls within their fiduciary responsibility to ensure that their decisions are in the best financial interest of workers who have contributed to the pension fund and rely on it for retirement security. Not considering climate risk puts all three elements of the duty in jeopardy.
Duty of Care
Fiduciaries must exercise reasonable care to prevent undue risks from harming investor portfolios, such as the systemic risk of climate change.
Climate change poses significant financial risks that can directly impact the value and stability of the pension fund's portfolio. Ignoring or underestimating climate risks exposes the portfolio to possible losses. For example:
Investments in industries vulnerable to stricter climate regulations (such as fossil fuel companies) could suffer devaluation or become stranded assets.
Physical risks, like natural disasters, could disrupt supply chains or damage properties, reducing the value of related investments.
Failing to assess and mitigate these risks means trustees are not exercising reasonable care to protect the fund's long-term health, which could lead to financial harm and breaches of their fiduciary responsibility.
Duty of Loyalty
The duty of loyalty requires trustees to act solely in the best interests of the workers invested in the fund. Trustees must protect the pension fund's financial security and climate risk directly threatens the fund's stability. If trustees ignore or fail to manage climate-related risks, the portfolio could suffer long-term financial losses which could be seen as favoring short-term gains over long-term stability, forfeiting workers' right to a secure, dignified retirement.
Duty of Impartiality
The duty of impartiality means fiduciaries may not favor those currently receiving retirement payouts over individuals just entering the workforce and whose retirement savings could be significantly affected by long-term climate change. Since climate risk is a long-term issue, neglecting it could harm future beneficiaries; specifically, the fallout of the climate crisis may devalue assets invested today. Ignoring climate risks may benefit those receiving short-term payouts before these risks materialize, but it unfairly harms future retirees, whose savings could be impaired by climate-driven financial instability. Properly managing climate risk ensures that both current and future investors are treated equitably.
Trustees play a pivotal role in advancing stronger climate risk-managed investment practices within pension funds. Spaces where trustees can help advance stronger climate risk-managed investment practices include:
During board or committee meetings or in spaces to offer feedback on reports by
Calling out the damage & risk of an investment policy that doesn't adequately cover climate risk.
Raising questions and pushing for quality standards.
Sharing other pension funds' model examples to shape the fund's policies and capacity to address climate risk.
If there is an assessment, pushing to assess the quality metrics and information the board is using to account for risk. If there aren't explicit or inadequate assessments of climate risk in investments, raise the need for it as part of the board's fiduciary responsibility.
Bringing in external climate risk advisors or consultants who specialize in integrating climate risk into financial strategies and portfolios.
In these spaces, trustees can ensure that climate risk is thoroughly integrated into the fund's investment approach, helping to safeguard long-term financial stability and fulfilling their fiduciary duties.
To learn more or to find tips and resources on mapping and reaching out to find allies and supporters as you take action toward strengthening your investment policy decisions, check out the Power of Investment section of CFA’s Investing in Our Future Guide.
