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Keeping up with Climate Change

Capital Market Assumptions: Medium to long-term scenarios and return forecasts

Climate change is arguably the most critical long-term challenge faced by humanity. It is also a key element for investors to factor in when building long-term economic and market assumptions.

Integrating key climate change mitigation into our asset allocation process


Ominous signs loom on the horizon in the return of inflation, the shift towards a new geopolitical order and, most importantly, the urgent need to tackle climate change. Factoring these trends into economic and financial forecasts will be key.

The changes driven by the energy transition will require a complete rethinking of asset class returns forecasting and have ramifications for investors now and in the years to come.

This year, we have analysed the implications of climate mitigation and Net Zero transition policies and introduced them in the definition of our capital market assumptions and climate risk aware portfolio allocation.

A new Central scenario and a painful Alternative scenario


The rebalancing of energy sources at a global level will drive the transition towards a greener economy. But this will not be linear and will come with increasing divergence across regions.

To assist our analysis, we also modelled an “Old World” environment where no specific climate policies or climate impact is considered.

Overall, our findings show the energy transition will further exacerbate regional and country divergences, as the five main macro implications from an active Net Zero 2050 climate policy will all bring higher fragmentation.

 

Implications for investors


Over a 10-year horizon, expected returns will be somewhat lower under the new Central Scenario (embedding climate considerations) compared to the Old World environment, while the Alternative Scenario will be disruptive especially for equity markets.

International - Asset class Views - central scenario impllication investor
Old world: No specific climate politics or climate impact considered.

 

Asset Class Expected Returns

Investors will have to focus on real returns amid higher structural inflation. Equities are preferred to bonds but with lower returns versus the past. Higher country/sector divergences and companies’ sensibility to energy prices will increase the dispersion of returns and offer stock picking opportunities.

Investors will have to focus on real returns amid higher structural inflation. Equities are preferred to bonds but with lower returns versus the past. Higher country/sector divergences and companies’ sensibility to energy prices will increase the dispersion of returns and offer stock picking opportunities.

Green asset reflation will be possible via monetary policies aiming to facilitate the transition. This will favour green bonds and EM.

Green asset reflation will be possible via monetary policies aiming to facilitate the transition. This will favour green bonds and EM.

Some Value sectors will be favoured (Energy, Materials, Financials) – which is a change from the previous decade – with a Quality tilt, as Quality has more stable EPS generation, and the usual Growth sectors in the US (IT, Communication Services), which will be a continuation of the past ten years. The contribution of dividend yields to total expected returns will be increasingly relevant.

Some Value sectors will be favoured (Energy, Materials, Financials) – which is a change from the previous decade – with a Quality tilt, as Quality has more stable EPS generation, and the usual Growth sectors in the US (IT, Communication Services), which will be a continuation of the past ten years. The contribution of dividend yields to total expected returns will be increasingly relevant.

International - Asset class view - equities

In our central scenario, EPS annual growth for the next 30 years is expected to decrease by 20% relative to the Old World(1). The Alternative Scenario will see an impressive 58% average decline in EPS growth.

 
In a world of higher inflation and structural upward pressures on raw materials and huge infrastructure investment needs, real assets will be favoured and deserve a greater allocation. Infrastructure is likely to benefit most, followed closely by Real Estate.

In a world of higher inflation and structural upward pressures on raw materials and huge infrastructure investment needs, real assets will be favoured and deserve a greater allocation. Infrastructure is likely to benefit most, followed closely by Real Estate.

Real assets 10Y forecasts – Central Scenario2

International - Asset class Views - Real assets - central scenario
As the alterative scenario (currently a low probability) will have a significantly negative impact, any events pushing in that direction may cause spikes in volatility and risk-premia repricing. Investors should stay watchful and keep structural hedges in place.

As the alterative scenario (currently a low probability) will have a significantly negative impact, any events pushing in that direction may cause spikes in volatility and risk-premia repricing. Investors should stay watchful and keep structural hedges in place.

You can no longer build long-term performance and understand the risks in your portfolio without embedding ESG deeply into the traditional investment process through a best-in-class approach; as such it is a revolution in the making.

Vincent MORTIER,
Group Chief Investment Office

Read more


1 Source, Amundi Institute. Data as of 27 of January 2022
Source: Amundi Asset Management. Amundi CASM Model. Quant Solutions and Amundi Institute as of 31 March 2022. Local Currency. ** Global Private debt refers to Direct Lending. These results were achieved by means of a mathematical formula and do not reflect the effect of unforeseen economic and market factors on decision making. The forecast returns are not necessarily indicative of future performance, which could differ substantially. Regarding real assets, the data represents the modelling of core (moderate risk) real estate and direct lending on the private debt side. We assumed a leverage in the range 20-30% for Real Estate and a leverage of 100% for Direct Lending. In private equity, we considered the risk premium (and the leverage) calculated using a Beta versus the public market. Unlisted infrastructure equity is represented by Edhec Infra300 index. These results do not take into account neither the potential value added from alternative asset specialists when they select and manage these assets, nor the very strong dispersion of returns within the different real and alternative asset types. In other words, these models do not consider any alpha component and can be considered representative of the average manager. Forecasts for annualised returns are based upon estimates and reflect subjective judgments and assumptions.

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