A practical approach for assessing physical climate risk across complex investment portfolios

Institutional investors are increasingly expected to assess and disclose physical climate risks across diversified portfolios. For many, especially those with large allocations to private markets, this creates a structural challenge. Data is often incomplete or fragmented, ownership structures are layered, and the level of assessment varies widely across managers and operating entities.

The question is no longer whether physical risk matters but how to approach it in a way that is proportionate, decision ready, and integrated with existing climate-risk workflows.

From our work across the Pathzero network, three principles help investors build a more systematic and practical approach.

1. Begin with a risk-based view of the portfolio

Physical climate risk should not be assessed uniformly across all assets. The starting point is understanding where risk actually matters for the portfolio. This requires combining three dimensions of exposure.

Financial exposure: how much capital is truly at stake.

The first lens is straightforward but often overlooked. Investors need to understand where the largest positions are and how these positions flow through direct holdings and third-party managers. A small asset in a high-risk location may be interesting, but a large position in a moderately exposed asset class could pose far greater financial consequence. Prioritising based on invested capital ensures attention is focused where climate impacts would meaningfully influence portfolio performance.

Inherent exposure: the nature of the business and where it operates.

Different businesses face different levels of sensitivity to physical climate hazards. Geographic location determines hazard probability, while the type of business determines how those hazards translate into financial outcomes. For example, an industrial asset in a flood-prone area faces a different exposure profile than a digital services provider in the same region. A risk-based approach evaluates both factors together to understand how hazards translate into operational disruption or financial loss.

Climate Relevant Industries (CRIs): sector-level insight into risk dynamics.

Pathzero’s Climate Relevant Industries framework helps investors move beyond generic hazard maps by classifying businesses into economic categories that have common climate sensitivities. Each CRI highlights the typical physical risks most relevant for that industry, the commercial levers that drive value such as production volumes, occupancy, price, or throughput, and how these levers may respond under different climate conditions. This allows investors to build a clearer view of which assets are likely to feel the greatest financial impact under a given scenario, and which may be positioned to adapt or outperform.

When investors combine financial materiality, inherent exposure, and CRI insight, they generate a far sharper picture of where deeper assessment is justified. This prevents diffuse, unfocused portfolio sweeps and instead concentrates analytical resources on assets capable of shifting the overall risk profile or driving strategic opportunity.

2. Align with recognised frameworks and test the quality of the underlying data

The evolution of financed-emissions reporting offers a valuable lesson. The introduction of PCAF and its data quality scoring system brought structure to an area that previously felt opaque. By giving investors a clear way to understand uncertainty in the numbers, PCAF enabled emissions data to become a usable input for transition-risk management.

A similar shift is required for physical risk. While the market has not yet settled on a single global standard, it is already possible to be more disciplined about how physical risk outputs are assessed and used.

A good starting point is to break the assessment into its core components:

• Hazard data. What climate models, scenarios, and time horizons are being used. How granular is the data spatially. Which hazards are covered and which are missing.
• Exposure data. How accurate and complete are the asset locations. Are they geocoded to the building or only to a postcode or city. Do you have basic asset attributes such as type, construction, and replacement value.
• Vulnerability assumptions. How does the model translate a hazard into financial impact. Does it consider building standards, existing adaptation measures, business interruption, and knock-on effects in the value chain.

For investors using vendor physical risk scores, this translates into a simple set of questions to ask:

• How is asset location data sourced, cleaned, and validated.
• What happens when information is missing.
• Which hazards and regions are covered and at what resolution.
• How are damage or disruption functions derived, and have they been tested against observed events.
• How are results expressed, for example as a score, a probability, or a financial loss estimate.

From there, it becomes possible to create a practical internal view of data quality, similar in spirit to PCAF. Some assets will rely on coarse hazard proxies and limited asset information and will sit at the low-confidence end of the spectrum. Others will benefit from detailed, asset-specific assessments and can be treated as high confidence. Making this distinction explicit is more important than chasing perfect data.

For Pathzero clients, this discipline is already becoming part of broader IFRS S2 preparation. Investors need a consistent view of both transition and physical risk, supported by transparent assumptions and clear data provenance. Simple internal quality scores help portfolio teams and risk committees decide which results are ready to influence capital allocation, and where further work is required.

3. Enable collaboration and maintain a dynamic assessment process

Physical-risk management is not a one-off exercise. It requires continuous refinement as new information becomes available. Gaps in knowledge need to be identified, prioritised, and addressed. Doing this effectively relies on collaboration across the investment chain.

Asset owners must often rely on third-party managers and the operating entities themselves to obtain the data needed for informed assessment. In private markets, this information does not flow automatically. Without coordinated engagement, physical risk assessments remain static and of limited use.

Pathzero’s network model helps solve this. By providing a secure environment where operating entities, fund managers, and asset owners can share data once and allow approved parties to access it, collaboration becomes more efficient. Investors can focus scarce resources on exposures that matter most. As new data is provided, scenario analysis can be updated using assumptions grounded in the realities of the asset rather than generic templates.

A practical pathway forward

Taken together, these three principles provide a practical framework for institutional investors seeking to build meaningful physical-risk insight across complex portfolios. Begin by focusing on material exposures. Use emerging frameworks to introduce consistency and transparency. Maintain a collaborative, iterative process that brings asset-level information into portfolio-level decisions.

This approach shifts physical-risk assessment from passive understanding to proactive management. As Pathzero continues to expand the flow of information across its network of fund managers and operating entities, investors gain the clarity needed to identify where risk is concentrated, where opportunities are emerging, and where action is most warranted.