The adverse socioeconomic effects of climate impacts are forecast to become more frequent and severe; and, as a result, investors will need to gauge the likely effects of climate risks on economies and capital markets to help improve investment decision-making from both the top down and bottom up, according to a recent paper.

Based on current information, a delayed transition is the most likely scenario to materialize, finds Fidelity International’s Global Macro Insights: Race to Net Zero paper, which maps the investment implications of a delayed transition, and aims to help investors understand the impacts of climate risk and how they can integrate these considerations into their investment portfolios.

A delayed transition assumes global annual emissions do not decrease until 2030 and strong policies are then needed to limit warming to below two degrees Celsius, according to the Network for Greening the Financial System. This scenario assumes new climate policies are not introduced until 2030 and the level of action differs across countries and regions based on currently implemented policies.

As a result, emissions exceed the carbon budget temporarily, the paper notes, and decline more rapidly to ensure a 67 % chance of limiting global warming to below two degrees Celsius.

This leads, the paper finds, to both higher transition and physical risks than the Net Zero 2050 scenarios, which assume global warming is limited to 1.5 degrees Celsius through stringent climate policies and innovation, reaching net-zero carbon dioxide emissions around 2050.

The interplay between climate risks and macroeconomic variables, the paper points out, such as growth, inflation and policy rates will affect asset-class returns in different ways, depending on the underlying components of their returns.

“Capital markets tend to lack the ability to price in highly uncertain risks and opportunities far into the future, a shortcoming that has the potential to create opportunities for research-led active strategies,” says Salman Ahmed, Fidelity’s global head of macro and strategic asset allocation. “It has become apparent that the risks and uncertainties associated with both climate change and transition activity are greater than previously thought, and climate risks are still being underestimated by investors, partly due to challenges associated with modelling their impacts.”