Universities Superannuation Scheme, the U.K.'s largest defined benefit pension fund, is taking a new approach to addressing climate risk in its portfolio.
London-based USS, with £73.7 billion ($96.5 billion) in assets, said in its 2023 Task Force on Climate-related Financial Disclosures report published in late July that it is working with the University of Exeter on new methodologies after realizing that climate scenario analysis used so far has "significant limitations."
This is the second year that pension funds in the U.K. are required to conduct climate scenario analysis and disclose risks under the TCFD framework. USS, with a 2050 net-zero goal, has used the framework voluntarily since 2018.
This year's report included an estimate of Scope 3 emissions, although it noted the limited availability and reliability of Scope 3 data.
One of the report's main criticisms of the current scenario analysis used by USS and other investors is "excessive focus on precise measurement" of climate risk impacts over long horizons and a lack of focus on shorter-term dynamics.
Other flaws noted were limited use in setting financial assumptions for investment returns and other variables; difficulty applying the analysis to bottom-up investment decisions; and inadequate modeling of physical risks that do not account for tipping points.
Those flaws have resulted in the analysis playing a limited role in strategic asset allocation decisions, the report said.
"Climate scenario analysis has the potential to become an important input to the asset allocation process," and climate and policy responses to it "are likely to represent one of the key drivers of the macro and investment environment over the next 20-30 years," the report said.
The collaboration with the University of Exeter to improve how climate risk is integrated in investment decisions will look for deeper understanding of physical and transition risks and a framework over different time horizons that assesses resilience of assets and portfolios, the report said.
USS Investment Management has already moved away from standard equity benchmarks to address climate risk, and is expanding a climate tilt applied to a developed equities portfolio to private assets for climate solutions.
A spokeswoman for USS said in an email that the climate tilt affects £5 billion of assets under management. While there are no current plans to expand the climate-tilted portfolio, "we are assessing other approaches to reducing the carbon exposure in our developed equities portfolio where it's financially beneficial," she said.
Whether the new approach is extended to all asset allocations will be considered after the University of Exeter report is published in September, the spokeswoman said.
