Top-Down Portfolio Implications of Climate Change

Abstract

This article reviews the significant progress in academic research on economic impact of climate change and explores the implications for expected returns and strategic portfolio allocation across major public asset classes. There have been numerous efforts to measure the environmental impact within a broader environment, social, and governance framework with a focus on microeconomic and firm-level implications. In this article, the authors assess the impact of climate change on long-term expected returns across asset classes from a top-down macroeconomic perspective. They use well-accepted climate risk scenarios to assess the potential impact of alternative climate scenarios on economic growth, inflation, and asset returns for major asset classes. Finally, they design hypothetical portfolios given these top-down assumptions and explore portfolio allocation implications.

TOPICS: ESG investing, legal/regulatory/public policy, tail risks, portfolio construction

Key Findings

• ▪ The authors assess the top-down cross-asset impact of climate change for strategic asset allocation in both optimistic and pessimistic scenarios.

• ▪ The top-down analysis suggests that growth-oriented assets, such as equities, would be directly affected by climate change. Their return would decline in the pessimistic scenario, with significant differences across countries.

• ▪ Using these strategic return expectations, a top-down climate risk–aware portfolio would tilt away from regions and assets that are expected to be adversely affected, particularly certain emerging markets, for better risk-adjusted returns.