Climate scenario modelling firm Ortec Finance sees climate change having a bigger impact on the equity market than fixed income in most of the climate outcomes it is analysing.
Ortec Finance provides five climate scenarios that help investors and banks to calculate the financial impact of climate change on investment portfolios by quantifying macroeconomic changes and analysing the effect on asset class returns under a range of different climate outcomes.
"In general, you could say that equities are more exposed in most likely climate scenarios than fixed income," said Bert Kramer, head of climate research at Ortec Finance.
"Equity valuations strongly depend on longer-term growth expectations, whereas bonds have relatively short maturities. Equity returns can respond quite dramatically to extreme weather or even minor changes in growth expectations."
The scenarios, which were designed with Cambridge Econometrics, include all major factors that are likely to impact the transition to net-zero, such as policy and regulatory changes, fuel and commodity price increases and the global uptake of renewable energy.
The five scenarios range from reaching net-zero by 2050 to a high warming scenario that sees temperatures rising to 2 degrees warmer than pre-industrial levels by 2050 and 3.7 degrees warmer by 2100.
The firm published its latest climate scenario update in April, which said the impact of the El Nino weather system will lower global GDP by 0.25% over the next two years, which will affect all asset classes.
The current El Nino is one of the strongest ever experienced, and is moving into its counter-phase La Nina, which will cause an increased number of extreme weather events and a temperature spike of 1.5 degrees this year.
Ortec Finance believes the most likely climate trajectory is currently a temperature rise of two to three degrees by 2100, which it calls the reference baseline.
The limited action scenario, which is based on current policy action, highlights cumulative returns on standard equities until 2040 of –18% for the EU relative to the reference baseline, compared with –31% for the US.
The net-zero financial crisis scenario sees climate risk being abruptly priced into the market in 2025, leading to overreaction and subsequent shocks that could wipe 7% off Paris-aligned equities and 15% off conventional equities.
Not priced in
Ortec said the impact of climate change is not yet fully priced into markets and sectors such as real estate and infrastructure are particularly exposed as insurance is withdrawn.
"Physical risk is only priced in the most obvious pockets, but to a limited extent." Kramer said. "I think banks will become more and more aware of the risks in their lending books and will take that into account more when they lend."
Kramer is not optimistic that the world will manage to stay below 2 degrees of global warming and sees 2 degrees as more realistic and achievable, but still very ambitious. This means that investors could be facing some of the more disorderly scenarios outlined and should prepare their portfolios accordingly.
"I think that financial markets should be very much aware of potential risks and market instability around key dates like 2025 and 2030 and make their portfolios resilient for different alternative futures," he said.