For the past four years, climate scenario analysis has helped us answer many of the questions around the investment implications of climate transition and how it can affect an investment portfolio. Our latest update is now available. Read the paper here.
COP29
In November, delegates from around the world gathered in Baku, Azerbaijan for the annual UN climate gathering.
While governments, companies and financial institutions are doing more than ever before, there remains a big disparity between climate ambition and credible action.
Attendees sought agreement on the financing that’s needed to get the world back on a path that would limit temperature rises to within 1.5°C above pre-industrial levels.
Climate adaptation – coping with the physical damage caused by climate change – was also on the agenda. With the increasing frequency of extreme weather events such as heat waves, storms and floods, the need for adaptation solutions has grown more pressing.
The discussions at COP29 reinforced the importance of investors having access to high-quality data and analysis to better assess portfolio climate risk.
Scenario analysis that reflects the real world
We’ve been modelling the effects of many climate outcomes – based on different climate policies and alternative technology development paths – on asset valuations.
Unlike other climate scenario analysis tools we don’t use a standardised ‘off-the-shelf’ solution.
Instead, we utilise additional scenarios tailored to include more nuanced, real-world sectoral and regional assumptions. In total, we examine 16 climate scenarios and assign a probability to each one.
Climate scenario analysis forms part of a suite of complementary tools – our climate building blocks – that helps investors meet regulatory requirements and adds value to investment decision making.
Scenario analysis needs to reflect the latest policy and technology environment
We update our climate scenario tool every year to reflect credible changes in policy, technology and the structure of markets, as well as how companies are adapting to the energy transition.
In ‘Navigating a delayed and more disorderly transition’, we look at recent developments and show how these have changed the assumptions that underpin the analysis.
Here are the key highlights from the latest update:
Climate policy ambition grows amid implementation delays. While climate policies are becoming more ambitious, their implementation is often postponed, leading to a more complicated energy transition with mixed effects for investors.
Risks are sector-, stock-specific. Climate risks vary significantly between sectors and individual companies within each sector. This presents opportunities for active managers to favour companies that are well-positioned for the climate transition and avoid those that are not.
Short-term demand creation. There are more short-term opportunities for companies driven by technological advancements, better competition within the electrification market, and a new cycle of infrastructure investment. For example, strong demand in China, compared to other markets, suggests its continued domination of climate solution technologies.
Expansion of investment universe. At the individual stock level, we see more companies provide climate solutions, indicating a growing number of investment opportunities in this fast-growing area. Boosts for technologies directly associated with transition technology (e.g. solar and electric vehicles) are accompanied by others more broadly for electrical components and equipment, as well as ‘future minerals’.
Prolonged stranded-asset risk. In the medium to long term, there is a higher risk of stranded assets in energy-intensive sectors due to delayed climate policy implementation and the gradual shift to low-carbon infrastructure.
Equity, credit risks persist. Both equity and corporate bond markets are affected by demand changes and carbon costs, but the performance benefits are more limited for credit markets.
Understanding the climate crisis should be a priority for investors
The climate crisis is one of the most important issues of our time, and understanding its potential impact is a priority for investors.
Policy changes, company commitments, technological progress and evolving consumer habits are all drastically transforming energy systems and economic activities.
That’s why a robust climate scenario analysis approach, one that is quantitative, forward looking and able to handle an ever-changing environment, should be in every investor’s toolkit.
We believe that our proprietary climate analysis framework, combined with active management, can help build more resilient portfolios and generate better long-term returns.