Executive Summary
- Investors today face dual climate risks that stem from both the transition to a sustainable economy and the increasing severity of physical climate events. Transition risks arise from rapid policy changes, technological innovations and evolving market behaviors, while physical risks include the damaging impacts of extreme weather, rising sea levels, prolonged droughts or productivity losses for workers exposed to heat. Together, these risks accelerate the devaluation of assets, potentially rendering them stranded long before the end of their expected lifecycles.
- Fossil fuels are not the sector on the watchlist. Real estate, automotive, agriculture and heavy industry are also increasingly vulnerable due to stricter energy standards, rapid technological advancements and tighter regulatory measures. In this context, investors need to reassess their portfolios across a diverse array of industries to fully capture the potential impact of climate-related disruptions.
- To identify which sectors are most at risk, we integrate three NGFS transition scenarios (Baseline, Net Zero 2050 and Delayed Transition) into two traditional financial valuation methods: Discounted Cash Flow (DCF) and Interest Coverage Ratio (ICR). Under the baseline scenario, current Nationally Determined Contribution plans are realized and even slightly improved but fail to reach a 2°C consistent pathway. The Net Zero scenario represents an aggressive policy environment with ambitious carbon-reduction targets, prompting an immediate yet more predictable revaluation that favors renewable energy, low-carbon technologies and sustainable business models, while stranding high-emission assets sooner. In contrast, in the Delayed Transition, policy intervention is postponed, triggering a sudden and disorderly asset repricing when climate action becomes inevitable, which is likely to destabilize brown sectors.
- Overall, we find that the technology and healthcare sectors show resilience under all climate transition scenarios in both the US and Europe, while the energy sector faces heightened vulnerability due to rising operational costs and regulatory pressures. DCF assessments under the Net Zero 2050 scenario reveal significant sector-specific corrections on both sides of the Atlantic. In the US, healthcare and consumer discretionary would each drop by roughly -16%, while energy and basic resources would face smaller declines of around -6% to -7%, reflecting partial adaptation via renewables and critical materials. In contrast, in Europe, real estate would suffer a severe hit of -40%, with telecommunications (-26.3%) and consumer staples (-24.8%) also seeing major setbacks. Even though basic resources (-11.9%) and technology (-11.7%) fare better by comparison, these results highlight the varying vulnerabilities each sector faces under aggressive climate policies. A well-orchestrated transition could help reduce the scale and speed of market disruptions in both regions. The ICR method reinforces the argument for an orderly transition. In the Net Zero 2050 pathway, both US and European sectors with heavier capital requirements – such as energy and utilities – would experience notable ICR declines, indicating higher capital expenditures and steeper CO₂ pricing. Yet under a Delayed Transition, basic resources and utilities would show moderate ICR improvements on both sides of the Atlantic, reflecting the near-term relief of slower policy changes. However, this reprieve risks compounding longer-term vulnerabilities as abrupt policy reversals or sudden shifts in market sentiment may ultimately trigger sharper and more destabilizing adjustments for those sectors. All in all, despite the initial valuation declines in sectors like healthcare and consumer discretionary under a Net Zero 2050 scenario, it is the only one that ensures long-term economic resilience.
- Against this backdrop, proactive risk management is essential for safeguarding long-term portfolio value in an era of rapid climate change. Early adoption of adaptive strategies, driven by comprehensive scenario analyses, can help investors mitigate the risks of asset stranding. By positioning portfolios to respond swiftly to emerging climate policies and market dynamics, investors not only limit potential losses but also capitalize on opportunities presented by the growing green economy.