Sustainable Investing and Climate Transition Risk: A Portfolio Rebalancing Approach

Abstract

The authors studied how greenness can be combined with other investment criteria to construct sets of corporate bond portfolios with decreasing exposure to climate transition risk. They apply the methodology to the European Central Bank’s asset purchase program. They define a weaker market neutrality principle as investing proportionally to the bond amount outstanding within Climate Policy Relevant Sectors. The portfolio rebalancing leads to a 10% reduction of exposure to climate transition risk. Then, the authors studied the relationship between bonds’ rebalancing and issuers’ environmental, social, and governance (ESG) characteristics and greenhouse gas (GHG) emissions. Bonds issued by firms with low (high) ESG risk and GHG emissions are more likely to be bought (sold) in the rebalancing. Finally, they analyzed the implications of portfolio rebalancing on financial markets, finding that changes in yields would be limited to less than 80 basis points on individual bonds. The approach can contribute to inform climate-aware portfolio rebalancing and sustainable investment strategies.