Global Weekly Commentary: Climate transition: a driver of returns
Climate-aware return assumptions
Our updated, climate-aware return assumptions support our strategic preference for developed market (DM) equities.
Rising inflation expectations have driven up U.S. 10-year Treasury yields but to a lesser degree than in the past. Real yields remain deep in negative territory.
U.S. nonfarm payrolls data will be in focus after a modest increase of jobs in January. Global purchasing managers index data will shed light on the restart.
We are incorporating the effects of climate change – and of the climate transition – in our return assumptions, as we believe avoiding climate-related damages will help drive growth and improve returns for risk assets. We see climate-resilient sectors as potential beneficiaries of a “green” transition, and are strategically overweight DM equities as they are skewed toward these sectors.
Chart of the week
Return assumption differentials in green transition vs. no-climate-action
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, February 2021. Notes: The chart shows the difference in U.S. dollar expected returns over the next five years from February 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 degrees Celsius 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.
We see climate change and efforts to curb it having major economic implications in the decades to come. The base case underpinning our updated capital market assumptions (CMAs) reflects a “green” transition to a low-carbon economy, with a gradual phasing-in of carbon taxes, green infrastructure spending consistent with the IMF’s recommendation, and subsidies on renewable energy. If none of these actions are taken to mitigate climate change, we estimate a cumulative loss in global output of nearly 25% in the next two decades. Our updated CMAs are driven by sectoral views, with exposure to climate risks and opportunities a key determinant. We see technology and healthcare benefiting the most from that perspective, and carbon-intensive sectors with less transition opportunities such as energy and utilities lagging. See the chart for estimated return assumptions of four sectors in our base case vs. a no-climate-action scenario. Climate is just one driver of asset returns. Other drivers such as valuation could be more powerful over the short term, as evidenced by energy’s strong performance so far this year.
Our updated CMAs are an important step in BlackRock’s journey of making sustainability core to our investment process, as highlighted in CEO Larry Fink’s annual letter. The journey started long before this year. We had laid down the case for sustainability as a driver of asset class returns in Sustainability: the tectonic shift transforming investing, and have developed new tools to assess physical risks to assets caused by climate change. We already experience the effects of climate change in our daily lives, in the form of extreme weather events and rising temperatures. Capturing the financial implications is not easy, but it cannot be ignored. Projections around climate change are highly uncertain. This is due to the complexity of modelling the dynamics and myriad dependencies between climate, carbon emissions, and economic variables. We are in uncharted territory. Systematic acknowledgement of the inherent uncertainty is therefore crucial, and is a key consideration when we consider the portfolio implications.
We refine our CMAs to include an important and often underappreciated return driver - climate change. This flows in to our CMAs through 3 channels: 1) the macroeconomic impact; 2) the repricing of assets to reflect climate risks and exposures, and; 3) the impact on corporate fundamentals. First, macro variables such as GDP growth will be different in a world that is transitioning to a low-carbon future, meaning traditional risk premia for all asset classes will change, in our view. Second, we don’t believe market prices yet reflect the coming “green” transition, meaning assets poised to benefit may have a higher return during the transition. Third, climate change and the efforts to address it will impact the profitability and growth prospects of companies, creating winners and losers.
The bottom line: We believe the transition toward a world with net-zero carbon emissions should reward companies, sectors and regions that adjust, and penalize others. These effects are now reflected in our climate-aware return assumptions. On a broad asset class level, we see DM equities positioned to capture the potential opportunities from the climate transition, at the expense of high yield and some emerging market debt. The composition of DM equity indexes is more skewed toward less carbon-intensive sectors such as tech and healthcare; equities also can better capture potential opportunities arising from the “green” transition, given that bonds have more limited scope for capital appreciation, in our view.
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