The BlackRock Investment Institute (BII) believes that tackling climate change will drive significant economic improvements over the coming two decades and that the commonly held notion that it has to come at a net cost to society is wrong. BII sees higher returns for certain asset classes and sectors due to their more favorable positioning for a shift to a global economy with net-zero greenhouse gas emissions. BII is unveiling new Capital Market Assumptions (CMAs), incorporating risks and opportunities tied to climate change. BII’s CMAs are a building block of portfolios the firm designs and implements for clients
“Climate risk is investment risk, yet there are also significant investment opportunities in the transition to a net-zero economy,” said Jean Boivin, Head of the BlackRock Investment Institute. “By quantifying those opportunities we can build portfolios that benefit from exposure to the transition, which is an integral part of our fiduciary duty to clients.”
Most economic projections do not yet factor in the potential costs of any physical damage from climate change; the costs and benefits of an energy transition; and the effects of policy changes, including increased government spending on green initiatives, associated with meeting the goals of the Paris Agreement. By incorporating these considerations, BII estimates that an orderly transition to a net-zero-emissions world could result in a cumulative output gain of nearly 25% over the next two decades, relative to no action being taken to prevent climate change.
Sustainable Asset Premium
“While the global green energy transition will benefit economic growth broadly, there are some asset classes and sectors better positioned than others as we shift to a net-zero world,” added Simona Paravani-Mellinghoff, Global CIO of Solutions within BlackRock’s Multi-Asset Strategies & Solutions business. “We expect investor capital will flow toward these more sustainable assets, creating outperformance for green investments and separating leaders from laggards.”
BII’s climate-aware CMAs imply that the likely sector beneficiaries include technology and healthcare over the next five years because of their relative lower exposure to climate risk, whereas energy and utilities could lag.
At the broader asset class level, the updated CMAs reflect a preference for DM equities at the expense of high yield and some EM debt. The composition of DM equity indexes better aligns with the climate transition, with large weights of technology and healthcare companies, less vulnerability to transition risks and lower carbon intensity. Equities also can better capture potential upside, as bonds are capped in their capital appreciation.
Climate-Aware Framework and Implementation
Although the implications for portfolio construction will vary based on client risk appetite and objectives, the updated CMAs use a framework for incorporating shifting investor preferences on sustainability into expected asset class returns.
BlackRock’s climate-aware CMAs account for sustainability by focusing specifically on climate-related inputs within ESG. For while there is wide recognition of the importance of social and governance concerns, there is greater consensus on the impact and measurement of environmental factors.
The updated CMAs include climate costs and benefits at three levels: macroeconomic inputs, including GDP; the price investors are willing to pay for sustainable assets; and the way companies are positioned for and may adapt to the green transition.
“We’ve designed the climate-aware CMAs through the lens of understanding how climate change and evolving global societal preferences will impact asset returns across macro, repricing and fundamental levels,” said Vivek Paul, Senior Portfolio Strategist for the BlackRock Investment Institute. “From that framework we are able to build new long-term asset class return expectations and then consult with clients on portfolio design to help meet their objectives.”
Despite uncertainty over the configuration of a net-zero-emissions global economy, the green transition is already underway and will play out over years, if not decades. BlackRock will monitor key trends such as capital flows, policy developments and technological advancements – and the way asset prices respond to them – and look to evolve its framework as new information becomes available.
BlackRock’s commitment to integrating climate considerations into its long-term return expectations was highlighted in the firm’s 2021 sustainability letter to clients. There is no company that will not be profoundly affected by the transition to a net-zero economy, and BlackRock believes climate-aware CMAs are an important step toward improving investment decision-making and portfolio design.
In February, BlackRock Investment Stewardship (BIS) also published a new commentary, Climate risk and the transition to a low carbon economy, which provided more detail on what BIS would like to see in company plans for prospering in a low-carbon economy.