Thin ice – Portfolios can no longer ignore the signs of climate change

By Wei Li, BlackRock Investment Institute

Li Wei

Severe climate events around the world have intensified debate about the effects of climate change and the risks they pose to portfolios. Investors should no longer view the transition to a low-carbon economy as a distant event. In our view, it is happening here and now. Climate risk is investment risk, and we think that the narrowing window for governments to reach net-zero goals means that investors need to start adapting their portfolios today.

The latest report from the United Nations’ Intergovernmental Panel on Climate Change (IPCC) confirmed an acceleration in global warming. According to the report, greenhouse-gas emissions from human activities are responsible for about 1.1°C of warming in average global temperatures since the 19th century, and the warming will continue for decades even with immediate actions to sharply reduce emissions. The IPCC still sees a narrow window for limiting warming to 1.5°C if there is a coordinated effort to achieve net-zero emissions by 2050.

Our climate-aware return assumptions rest on a successful transition to a low-carbon economy consistent with Paris Agreement. That would deliver an improved outlook for growth and risk assets relative to doing nothing. We see climate-resilient sectors such as technology and healthcare as likely to benefit the most from a ‘green’ transition. Carbon-intensive sectors with fewer transition opportunities, such as energy and utilities, are likely to lag. See the chart below for the return assumptions in our base case compared with a no-climate-action scenario.

Extreme weather events have helped to make climate risk a key concern for investors. Consider the two baskets of climate risks: physical risks (think of hurricanes and wildfires and their potential damage to real assets) and transition risks (financial risks arising from the transition to net-zero, stemming from changes in taxes, regulation, technology and business models). As the IPPC points out, the window for a successful transition to net-zero by 2050 – a goal set by many governments – is shrinking.

We could see the window for positioning portfolios shrinking too. Accelerated actions to reach net-zero would entail transition risks being more rapidly priced in by financial markets. Otherwise, we are likely to see continually accelerating physical risks. All in all, the pathway to net-zero remains highly uncertain, but regardless of the route taken, we see an acceleration in the implications for portfolios.

The bottom line

We are still in the early stages of a tectonic shift toward sustainable investing.

Market prices do not yet reflect the full consequences of this shift. During this period of change, we expect ‘green’ assets that are likely to benefit from the transition to a low-carbon economy to outperform. This is one reason for investors to keep tabs on the progress of both climate change and the climate transition. We see two key aspects to the climate transition: technology and policy.

The tech transition has already begun in some sectors, such as utilities and autos. As the window to achieve net-zero by mid-century narrows, we expect policy levers to be pulled harder. This could result in a steeper transition. We believe that doing nothing about climate change in portfolios is no longer an option.

Winners and losers

For illustrative purposes only. This information is not intended as a recommendation to invest in any particular asset class or strategy or as a promise – or even estimate – of future performance. Sources: BlackRock Investment Institute, with data from Refinitiv Datastream and Bloomberg, August 2021. Notes: The chart shows the difference in US dollar expected returns over the next five years from August 2021 for four sectors of the MSCI USA Index in our base case of a ‘green’ transition (policies and actions taken to mitigate climate change and damages, and to limit temperature rises to no more than 2°C by 2100) vs. a no-climate-action scenario. The estimated sectoral impact is based on expected differences in economic growth, corporates earnings and asset valuations across the two scenarios. Professional investors can access full details in our Portfolio perspectives and CMAs website.

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