Capital market assumptions

Our macroeconomic and asset return forecasts account for the impact of the low carbon transition and climate change and our underpinned by the BII Transition Scenario. This is our research-based, analytical forecast of how the low-carbon transition could unfold. Its value is not in the forecast itself, but how it can be used to help investors navigate the transition’s risks and opportunities. It focuses on what is most likely to occur – rather than on what anybody thinks should happen or a specific outcome. The low-carbon transition’s speed and shape are highly uncertain and the BIITS cannot capture all the transition’s drivers and all the ways physical climate events affect the economy and markets. We approach this process with humility, knowing we may be wrong about some aspects.

The BIITS is not designed to capture dynamics for companies or assets, nor does it assess whether markets have priced in opportunities and risks. It is not intended as a recommendation to invest in any particular asset class or strategy or as a prediction of future performance.

Our methodology and assessment of its effects are inherently incomplete, especially further out in the future. We plan to adjust our views as we learn more.

The BII Transition Scenario modelling allows us to account for the impact of physical climate damages, transition-related costs and capital investment – key channels for the transition’s impact on growth, in our view. We use an iterative framework to estimate the impact of the transition and physical climate change on economic growth, considering energy prices, energy production and consumption. across the global economy through 2100, and the expected economic damages that may result from worsening physical and transition risks.

On inflation, we assess the likely impact of the transition across countries based on an estimated net increase in energy prices and capital investment to finance the transition.

We arrive on a view on the impact on policy interest rates based on our assessment of the monetary policy response given the estimated inflation and GDP growth impact.

We adapt the inputs to our asset return models to account for climate change, as described below.

Firstly, our estimated asset returns are underpinned by the macroeconomic impacts discussed above.

Climate change and the low-carbon transition also impact expected returns via two further channels:

Repricing – We think a consequence of shifting societal preferences for sustainability is that the average price investors are willing to pay for assets perceived to be sustainable is changing, meaning the discount rate we use to value these securities is also changing. For credit and equity markets we adjust our future cost of capital estimates, such that all else equal, more/less sustainable sectors have lower/higher future costs of capital.

Fundamentals – We see climate change and the low-carbon transition potentially impacting the profitability and growth prospects of companies. We estimate the impact of both physical and transition risks on corporate earnings at the sector level, taking into account macroeconomic shifts like changes in growth or demographic trends, changes in supply and demand for less carbon intensive assets, and the ability of companies to adapt to such changes. We also account for the evolution in power and energy systems – as estimated by the BII Transition Scenario - from emissions-intensive companies to efficient and renewable business models.