Climate criteria in asset allocation

Climate criteria in asset allocation

In view of climate risks and the ambitious goals of national and international climate protection policies, capital investments are being allocated more and more based on the risks and opportunities inherent in climate change.

Fad-resistant, like the rings of a tree: when it comes to capital investments, medium- and long-term asset allocation is where it’s at.

© BayernLB

Long-term security? Climate risks as a new factor

Strategic asset allocation is a method used by investors to distribute their capital investments across various investment categories, regions and currencies in the medium to long-term. In the context of  climate risks and the ambitious goals of national and international  climate protection policy, the opportunities and risks presented by climate change should also be factored into this investment decision. The question of how climate change and climate protection policy will affect the value of each category of asset is central to this process.

Different climate scenarios – different risk ratings

The climate scenario that is predicted for the future is critical to evaluating the level of risk. The Paris Agreement objective of limiting the global rise in temperature to well below 2 degrees Celsius is an important point of reference – but is by no means the sole point of reference. Climate scientists from the Intergovernmental Panel on Climate Change (IPCC) have developed a number of potential scenarios for greenhouse gas emissions and climate change. These scenarios also include the possibility of a 3 or 4 degree Celsius rise in temperatures. This kind of increase would bring a completely different set of challenges for strategic asset allocation compared with a 1.5 or 2 degree rise.

Temperature curve of individual investment categories

If the 2-degree objective is met, it could have positive effects in emerging market equities, infrastructure, real estate, timber and agriculture. With the exception of infrastructure, failure to meet the Paris climate objectives and a rise of 4 degrees Celsius in average global temperatures would have a negative impact on all of these investment categories. These conclusions were published in the study “Investing in a Time of Climate Change”, which was commissioned by the WWF in partnership with a number of other organisations.

Stranded assets

Illiquid investment categories in particular are assets that are at risk of medium to long-term “stranding”. “Stranded assets” are investments or assets that are subject to an unexpected decline in value or cannot achieve the planned yields due to an (unpredicted) change to regulations, environmental conditions or technology before the end of their planned life. Examples of stranded assets may include:

  • Fossil fuel power plants that may no longer be operated after the implementation of more stringent energy efficiency and emissions criteria
  • Real estate located in an area that has been newly defined as a flood plain

A climate-oriented asset allocation process helps to ensure that capital investments remain on track in the long term.