The Mirror and Window: Pension Funds Need the Full Picture on Climate Risk

When it comes to climate change and investing, how we understand risk shapes our decisions. For decades, traditional finance has taught us to look in the mirror and to focus on how the world affects a company’s bottom line. Is a factory at risk of flooding? Will supply chains be disrupted by wildfires or drought? This view of materiality centers on what matters to the company and its investors.

But that’s only half the picture.

Many investors, regulators, and workers are coming to realize the need to look out the window and understand how the company affects the world. That broader perspective is called double materiality, and it changes how we assess climate risk, corporate responsibility, and value.

Let’s unpack both mirror and window concepts and explain why this broader view of risk is especially important for public pension funds.

Double materiality incorporates the impact that investment decisions have on the broader environment, in addition to the traditional risk-based approach to sustainability, which considers financial risks and opportunities in isolation (Khalid Azizuddin, Responsible Investor). 

Understanding Double Materiality

In traditional finance, materiality refers to information that could significantly influence investor decisions, like market shifts, legal risks, or a company's financial performance. Think of materiality as a mirror. It reflects how external forces like extreme weather might affect a company's house (business). Investors look into that mirror to assess how these risks could damage the house's value or disrupt its operations. In this view, climate change becomes material only if it directly threatens a company's operations or profitability. It's like holding up a mirror to the company to see how external forces like an unexpected, severe climate-fueled storm might damage its value.

Double materiality broadens that lens. It still looks in the mirror, but it also looks out the window to assess how a company's actions, like carbon emissions or poor labor practices, affect the environment, the economy, and communities. It lets us see how the house itself, through activities like burning fossil fuels or draining local resources, impacts the neighborhood around it. It's a two-way relationship: how the world affects the company, and how the company affects the world.

Both perspectives are essential for a complete view and a better understanding of risk, responsibility, and long-term value. This view is critical for managing climate risks and making investment decisions that ensure consistent, sustained returns.

Why This Matters for Public Pensions and Climate Action

Public pension funds are built for the long haul. Their purpose is to provide retirement security to the workers who are invested. But when funds focus only on the mirror of traditional materiality, they risk missing half the story.

Yes, climate disasters, supply chain shocks, and political instability can disrupt returns. But just as importantly, the companies these funds invest in can cause those very disruptions through polluting practices, extractive business models, or resistance to climate solutions. Without the window of double materiality, pension funds may inadvertently fuel the climate crisis they should protect against, undermining financial performance and the future that workers are retiring into.

Pension trustees and the investment managers these funds hire have a fiduciary duty to safeguard retirement benefits. That means accounting for climate risk as a clear and present threat. Double materiality strengthens that duty.

It pushes us to ask:

• Are our investments contributing to or mitigating climate risk?

• Are companies being evaluated not just by their financials, but by their impacts on workers, communities, and ecosystems?

• Are we supporting systems change or standing in its way?

This lens isn't about sacrificing returns. It's about seeing the full picture and making better-informed, more resilient investment decisions.

Seeing Clearly. Acting Boldly.

Protecting public workers' retirements requires more than hitting a target return. It demands a commitment to investing in a future where dignified retirements are still possible. That future depends on how we respond to climate risk and whether we're willing to look beyond the mirror and out the window.

Public pension funds that embrace double materiality are better equipped to fulfill their mandate, protect long-term value, and help drive an ethical transition to a more inclusive and sustainable economy.

Because in the end, what's outside the window will shape what we see in the mirror.

Note: The analogy used in this blog was generated with the support of AI.