NEST analysis finds orderly transition is biggest short-term threat to portfolio

UK workplace pension scheme publishes first mandatory TCFD report with scenario analysis by Aon.

NEST’s portfolio is most at risk in the short-term from an orderly transition to a low-carbon world, analysis commissioned by the UK workplace pension fund has suggested.  

The £24 billion ($27.7 billion; €27.6 billion) scheme published the results of the scenario analysis, which was performed by consultant Aon, in its TCFD report on Tuesday.  

Under the orderly transition scenario, which assumes governments take prompt and coordinated regulatory actions to tackle climate change, NEST’s portfolio would fall by £3.5 billion over three years against a baseline case.  

In the long term, however, Aon’s analysis found that NEST’s portfolio performs worst in a disorderly transition, with £71 billion being wiped out over 30 years. This scenario is worse than one in which no transition is undertaken, which sees the fund lose out on £50 billion against the baseline. 

An orderly transition pays dividends over the medium (10 years) and long-term (30 years), adding £14.6 billion and £89.5 billion, respectively.  

“In the first years of an orderly transition, equity performance is expected to be poor and this is likely to have a pronounced negative impact on asset returns,” NEST wrote. 

The scheme said near-term harm inflicted under the scenario is mitigated by the climate tilts it has applied to its equity funds.  

NEST’s TCFD report is its first under the mandatory requirement introduced by the UK government last October. The first round covered schemes with more than £5 billion in assets. Next month, the threshold will drop to £1 billion.

The UK’s largest private pension fund, the Universities Superannuation Scheme (USS), has also released its first TCFD report since the new regulation came in. It found that in the short term (five-10 years) it was the disorderly transition scenario, one of three used in its analysis, that would result in the worst outcome for the fund.  

The £91 billion fund for UK academics warned however that the scenarios, which were produced with Ortec Finance, include “significant assumptions, so actual numbers generated by the process should be treated with great caution”. 

Aon worked with the Cambridge Institute for Sustainability Leadership to develop the five transition scenarios used on NEST’s portfolio, which include abrupt transition, orderly transition, smooth transition, no transition and disorderly transition. 

The scenarios capture physical and transition impacts but are not yet able to model “extreme ‘tipping points’ in the climate system when critical thresholds are exceeded”.