Climate Change and Asset Allocation: A Distinction That Makes a Difference

Abstract

It has become generally accepted that climate change affects economic variables such as growth and inflation. Via these economic channels, it is likely that climate change will also affect asset returns and risks. The authors provide evidence-based estimates of what these effects are and discuss how to incorporate climate change to build portfolios that are robust to a variety of climate change scenarios.

TOPICS: Portfolio construction, ESG investing, risk management, tail risks

Key Findings

• ▪ Climate change will likely lower economic growth and equity returns while increasing equity market volatility.

• ▪ A simple example is used to show how to incorporate various climate change scenarios into asset allocation decisions.

• ▪ Based on empirical risk and returns for traditional and highly rated environment, social, and governance indexes, it is a simple matter of using constrained optimization to achieve investment outcomes with sustainability goals or constraints.