The Role of Climate Change Scenarios In Investment Portfolios

Commissioned by Singaporean investment entity GIC, this report presents the results of assessing the impact of climate scenario analysis on long term capital market returns. The climate transition will impact expected returns and market volatility due to climate-related transition and physical shocks.

We used the E3ME macroeconometric model to quantify the transition and physical risk impacts associated to climate scenarios, considering Cambridge Econometric’s three scenarios, (i) Paris Orderly Transition; (ii) Delayed Disorderly Transition; (iii) Failed Transition. In partnership with Ortec Finance, we assessed the investment opportunities presented by a low-carbon transition. While physical risks are negative, transition risks are net positive for the economy and bring along new investment opportunities.

Key Findings

  • Transition risks have a net positive impact on the economy as policy responses such as the carbon taxes collected are used to reduce income taxes and increase subsidies for clean energy, resulting in a net fiscal stimulus, while low carbon investments boost aggregate demand.
  • However, there is a wide dispersion of growth impacts across countries and sectors, varying across different scenarios.
  • Risk assets like equities and real estate are more sensitive to climate change compared to bonds and cash, though equity markets with very low exposures to low carbon electric utilities (e.g. emerging markets) have more potential to outperform in the transition scenarios due to larger room for the sector to grow.
  • Climate change scenario analysis plays a central role via top-down strategic asset allocation, stress-testing and risk management, and the bottom-up integration of scenario inputs and outputs into our active investment processes.
János Hidi Sustainable Investment Manager