Climate Change and Asset Management

Abstract

In this article, the authors explain how asset owners and asset managers should behave to cope with new regulations and risks related to climate change. By optimizing portfolios with constraints on the global portfolio carbon footprint, it is possible to construct equity portfolios and indexes with a low carbon footprint without penalizing returns. In the future, there will be costs and opportunities as a result of the process of transitioning to a low-carbon-emission economy. The authors explain how building future scenarios for assessing the climate consequences of more- or less- stringent actions and regulations will be challenging because doing so requires integrated assessment models that integrate climate science with economic data and predictions. According to the authors, bond investors offer more promise in forcing corporations to adopt policies to reduce carbon emissions than do equity investors by affecting funding costs. This can be done through carbon emission reduction covenants in corporate bond indentures and carbon policy performance bonds; the latter can be used to control government performance as well as corporate performance. On the financing side, green bonds can be used to fund carbon emission reduction projects. TOPICS: ESG investing, portfolio theory, portfolio construction Key Findings • Climate change will affect asset owners and asset managers’ decisions in at least three ways: (1) compliance with rules to mitigate climate change, (2) coping with the risk of severe damage to physical assets in their possession or in the possession of the firms they own, and (3) impact on economies and societies. • It is possible to construct portfolios and indexes with a low carbon footprint without penalizing returns. This can be achieved by optimizing portfolios with constraints on the global portfolio carbon footprint. • The debt market offers more promise for affecting corporate and government carbon emission policies than does the equity market.