Climate scenarios: so what, and what’s next?

As with any investment, your capital is at risk.

The global climate challenge poses not one but two simultaneous transitions. A technology transition in energy sources and uses, and an unparalleled shift in our physical environment. While many of us may feel on familiar ground with the potential disruptions new energy technologies offer, none of us has been exposed to the extent of physical change that science predicts. And across both transitions sits an extra layer of unpredictability concerning social values and government policy.

To navigate this effectively, investment teams require great scenario awareness. The twin transitions will have impacts across the whole economy with consequences well beyond their immediate effects. Local outcomes could be very different from a global average. Complexity and unpredictable step-changes will be rife. 

Your preconceptions or worldviews may not be those that win out. Identifying the themes that endure across different futures and the flags that indicate which pathway is emerging should be a source of edge.

The same challenge applies whether you approach climate as a purely dispassionate observer or as a clear advocate for a rapid shift to low carbon.

Over the last couple of years, we’ve developed our use of scenarios to help us integrate climate themes into our investment process. We began the initiative after finding significant limitations in ‘quantitative’ tools that claimed to give precise numerical answers about risk and opportunity. They are narrow, probably misleading and quite unsuited to the needs of an active, concentrated portfolio manager. So we went back to basics. 

With external partners and much internal debate, we now have a set of ‘qualitative’ narrative storylines that run the gamut from climate success to failure. Each explores a different but plausible, internally consistent vision of the future. The stories combine technology, the economy, society and the natural world without having to shy away from the complexities or dislocations that would break a ‘quant-based’ model.

You can read more about our approach here and download our backup materials here and here.

Using these narratives, our investment teams have become better educated about the possibilities that lie ahead. They have exposed and debated differences of opinion, identified knowledge gaps and now ask better questions of companies. If portfolios tilt more toward one outcome than another, it is a more conscious choice. And as the opportunities evolve, we can adapt – or develop new – perspectives.

Identifying specific, attributable outcomes from the scenario work is nonetheless tricky. The value is really in strengthening decision-making. It is not so much about what we should do but what we should know and think about.

Common threads

Here are six themes that stand out from the many single-team and cross-team scenario workouts that we’ve conducted:

1.    Physical climate change is a discussion that needs to be had.

We find it hard to envisage a future geography that’s very different from the past – despite the overwhelming scientific consensus and, increasingly, the events we witness around us. The narrative approach brings predictions for the natural world to life through tangible, relatable examples.

This improves understanding, which in turn sets up better conversations with companies and better identification of risk concentrations within portfolios. We still have much to learn in this area. Our investment teams are undertaking follow-up work in company and country case studies, challenging their thinking about globalised business models and testing conventional macroeconomic assumptions.

Example: 
We have collaborated with the University of Exeter’s world-ranked climate team to explore the sensitivities across Tesla’s supply chain to future climate events as a template for deep-dive analysis. This led to further engagement with the company. 

Example: 
We reinforced our investment thesis for MercadoLibre’s region-focused ecommerce business model. And we stimulated further consideration of the global logistics and sourcing dependencies of Amazon and PDD Holdings, the owner of Pinduoduo and Temu.

Example: 
Our Multi Asset Team explored how compounding interruptions in the supply of physical commodities would likely affect inflation and what the monetary policy responses could be.

2.    Key energy technologies have passed the tipping points of mass adoption.

These technologies endure across all scenarios. Electricity is now the dominant form of energy supply growth. Wind and solar are the primary sources and are being enabled by advances in batteries, smart monitoring systems and new materials. 

However, pace varies significantly between the scenarios, especially between regions. The slower the deployment of new energy technologies, the slower their costs fall, delaying innovations that depend on their widespread use. 

Moreover, the longer it takes for them to displace incumbent carbon-emitting fossil fuels, the longer they will require government support. We need to better distinguish between the technology versus policy dependencies of climate solutions and reflect these different risk profiles in our portfolio construction. 

Example: 
The products of companies such as BYD (electric vehicles) and Enphase (microinverters, which optimise solar panels’ performance and convert the electricity they generate into a useful form) are now commercial without additional policy intervention. This contrasts with the advanced chemistry of Solugen and Lanzatech (low carbon materials and fuels) that, while attractive, still need policy signals to displace incumbents at speed.

Example: 
Joby’s electric aircraft will help solve climate-related challenges but may have a faster route to market with a more permissive approach to regulatory oversight of new technologies.

3.    Slower, messy futures will allow transitional solutions to persist for longer. 

These solutions include natural gas, simple biofuels, hybrid cars and fossil-based hydrogen. Each offers a lower-carbon pathway but not a zero-carbon pathway. They optimise rather than disrupt. As ‘better-than-nothing’ alternatives, they may offer interesting investment opportunities. But, like the second-order innovations noted above, they carry higher policy risk and are likely region-specific. 

Example: 
Li Auto’s extended-range electric vehicles allow consumers to bridge the technology and perception gap from combustion engines to full battery power.

TOTALEnergies may prove to be one of the few examples of an oil-and-gas major that can manage the energy transition and retain scale. A slower pace allows a steady shift in cash flows, investment and people, with a range of fuel options meeting differentiated customer demands.

4.    Local becomes more important than global. 

All of the above point to greater geographic fragmentation – be that in the energy and technology mix or shifting patterns of human settlement and the local efforts made to adapt to heatwaves, floods and other environmental challenges. This should give us more confidence in the growth of new energy technologies across scenarios as they offer self-sufficiency and reduce reliance on the more fragile inter-region flows of oil and gas.

We should expect different technology stacks in different regions and be clever enough to manage that nuance as investors. Physical climate change will disrupt supply chains and may open or protect local business models over global ones.

Example: 
Shopify’s solutions for local businesses are reinforced relative to the global e-commerce giants.

Example:
Semiconductor chip manufacturing is expanding in developed markets to access more renewable electricity, water and integrated manufacturing, in addition to the response to geopolitical tensions. This would support companies such as Texas Instruments.

Example: 
EOG in the US and Origin Energy in Australia are likely to have a long runway for their domestic gas assets, given the local cost competitiveness of gas as a power-peaking fuel, in contrast to the high price of imported gas in many other markets.

5.    Intermediaries will flourish in the complexity.

Uncertainty will be rife outside of a policy-led, rapid, orderly, low-temperature future. How do I get insurance? Where do I build my factory? What is the best logistics for my supply chain? What appliances do I install? What car do I choose? What mix of energy sources is right for me? How do I retrofit and weather-proof my building? What’s the best way to finance a purchase that is expensive to buy but cheap to run?

All this creates business and profit opportunities for those with the expertise or resources to navigate such complexity.

Example: 
Equipment and product suppliers such as Atlas Copco, Beijer Ref and IMCD optimise their decentralised business models to better provide the best mix of products for each customer’s location and value chain.

Example: 
Global transport services provider DSV helps clients navigate the complexity of logistics: fuels, routes and vehicles.

Example: 
Marsh McLennan’s broker model continues to match clients with effective insurance.

Example: 
Faced with regional policy, technology and weather volatility, property services and investment specialist CBRE Group enables its clients to access appropriate real estate and make the right decisions on refurbishment and resilience.

6.    New solutions from necessity not choice.

As the world warms, adaptation will be table stakes. This will involve first- and second-order effects. In addition to defensive infrastructure, first-order changes will likely include innovations that we thought of as low-carbon solutions in rapid, orderly scenarios.

We will likely have to turn to non-dairy and meat alternatives, not because they are lower-carbon but because existing agriculture cannot be sustained with higher temperatures and less water. 

The second-order changes will include societal adaptations. A harsher climate could reinforce the shift to online entertainment. Migration may well need financial innovation – be that digital currencies or money transfers. Inter-state tensions will almost certainly increase demand for defence and cybersecurity. Primary healthcare – vaccines – may require greater investment. Pest control could become an unfortunate must-have. Shorter life expectancies could underpin a consolidating funeral sector.

There is a sense of the increasingly extreme in this list, but these are all topics we have debated as we’ve sought out specific investment opportunities for concentrated growth portfolios.

Examples:

Our current holdings include:

• Genus – livestock genetics
• Roblox, Netflix and Spotify – online entertainment
• Wise and Blockstream – fintech
• AeroVironment – drones and other robotic systems
• BioNTech – vaccines
• Service Corporation International – funeral services

Disorderly scenarios

Stepping above our bottom-up stock picking, our teams have also become more questioning of consensus macroeconomic forecasting. We are in an odd situation where pretty much every central bank or multilateral financial institution presents a set of climate-influenced scenarios in which each future – whether rapid transition, runaway temperatures or disorderly progression – is worse than the ‘base case’. 

But what is the base case? How can any future be climate (or energy) agnostic? Why are rapid, orderly transition scenarios often presented as more inflationary than systems shocked by climate disasters or sudden government interventions? How would monetary policy respond to inflationary spikes caused by primary commodity shortages? What macroeconomic differences would result from subsidy-led policy versus carbon taxation? At what point does the insurance sector, the vital risk intermediary in a capitalist economy, start to fail at scale? How should we consider the shifting economic strengths of different countries and regions?

Underpinning overall asset allocation, our Multi Asset Team has begun to explore these questions through the lens of different disorderly scenarios. By estimating the appropriate macroeconomic indicators for each pathway, the team was able to re-cut its long-term return expectations across asset classes. You can read more about this project here.

Examples:
Integration of physical climate risks into the assessment of country-level GDP and the pricing of government bonds. In Q3-2023 this resulted in a decision that those offered by Peru did not offer sufficient compensation for the risks.

Example:
Elevated concern that the pricing of insurance-linked securities (ILS) does not fully account for wildfire risk. 

What’s next?

So far, the structure of most of our team scenario workshops has been to create familiarity with the scenario narratives while challenging investment teams to identify companies that are particularly sensitive to different futures. This supports the development of a mental toolkit that we can then apply to all idea generation and stock ownership. As a process, it fuels a curiosity to fill knowledge gaps and develop new sources of insight.

Writing this in February 2025, within weeks of the inauguration of an openly emissions-agnostic US presidency, a new narrative arc is high on our to-do list. How might we imagine a successful global society in a high-emissions world? What would a maximum-adaptation case look like in terms of key technologies, business models and locations? What implications might that have for our investment opportunities in different sectors and companies over the next five to 10 years?

In terms of our client mandates, the scenarios provide a framework for evolving the approach of our funds that act explicitly to support the goals of the Paris Agreement for rapid emissions reduction. With pathways consistent with limiting temperature increases to 1.5C, or even ‘well below’ 2C, seeming ever more unachievable, how do we judge corporate leadership? Against what do we benchmark ambition?

We have already used our scenario work to extend the focus of such funds from mitigation to adaptation and to help our assessment of regional ‘fair shares’ (the contribution a region should be expected to make towards global climate action based on its historic, economic or other capability). Expect us to increase the sophistication of how we construct, manage and describe our net-zero supporting funds throughout 2025.

Lastly, and to the point of broader impact, one of the reasons we set out to create our qualitative approach to climate scenarios was the weakness of the quantitative models. It has been heartening to see the ‘quants’ taking some of the criticisms on board and regulators engaging with the risks of false comfort that forcing disclosure of meaningless numbers creates for asset owners.

The most recent scenario modelling updates from the global collaborative of central bankers – the Network for Greening the Financial System (NGFS) – provide more granular views of the near-to-medium term and significantly increase the implied economic costs of future climate damages.

The world is fundamentally too complex to fit on a spreadsheet, but elements are ‘quant-able’, and we want to continue to share our experience of scenario work with those trying to help the informed balancing of risk and return.

Scenarios in action: a question framework for investment team workshops 

Scenario baselining:

Q1: Assumptions

• What scenario do we believe we are currently in? What variations in, or deviations from, this scenario might we expect in the future?

Company/thematic level:

Q2: Sensitivities

• At the company, regional, or industry level (whichever is most appropriate to the fund) identify stocks particularly sensitive to the different futures. How do the different scenarios introduce significant risks or opportunities to the investment case?
• Identify stocks that are more resilient to a disorderly transition. What characteristics do these have?

Portfolio level:

Q3: Alignment

• Aggregating the perspectives from Q2, to what extent is the portfolio ‘hedged’ for different transition outcomes, or is it mutually reinforcing in a particular direction? How does this align with assumptions made in Q1?
• Consider this through the lens of both technology transition and physical climate change.

Q4: Opportunities

• Do the assumptions made in Q1 point to any new sectors, regions, or technologies on which to focus future ideas generation?

Watch fors:

Q5: Indicators

What might change that would make us reassess our verdict for Q1, or heighten risks/opportunities for Q2 and Q3? Are there any indicators or trends we should track to confirm, challenge and monitor our assumptions over time?

Risk factors

The views expressed should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.

This communication was produced and approved in February 2025 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.

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