- Director of Multi-Asset Research
- London
Skip to main content
- Insights
- Capabilities
- Funds
- Sustainability
- About Us
- My Account
The views expressed are those of the author at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.
A climate-change framework for multi-asset portfolios
Whether investors are interested in holistically incorporating climate objectives into their portfolios or simply want to better understand different climate-aware investment options and their potential trade-offs, our three-pillar framework can help.
As the momentum behind decarbonisation and net-zero objectives builds around the world, asset owners are increasingly engaged in addressing the investment implications of climate change. The focus thus far has largely been on implementation at the security- and manager-selection levels, but there is a growing recognition of the need to factor climate change into broader investment policy and asset allocation decisions. To help with this process, our Investment Strategy Team, in partnership with our Climate and ESG teams, recently completed a comprehensive effort to integrate climate risks into our capital market assumptions (CMAs).
Our CMA process follows a classic building-block approach in which the components of total return — income, growth and valuation — are forecast independently. At the heart of the approach is an assumption that macro variables (e.g., GDP, inflation) and fundamental variables (e.g., EPS growth, credit losses) each have a bearing on total return.
With this as our starting point, we needed a framework for thinking about the climate inputs that should be incorporated into the CMA process. We chose to focus on two areas of climate risk:
Given the complexities and variations in the categories of climate risk, we employed two distinct approaches to estimate their impact on macro variables. For transition risk and chronic physical risk, we followed a scenario-based approach that draws on policy scenarios designed by the Network for Greening the Financial System (NGFS), a group of central banks and supervisors. The output from three different integrated assessment models is available for each of the scenarios, providing some model-risk diversification in estimating potential paths for real GDP and inflation. Figure 1 shows 12 of these paths for US real GDP (left) and 12 for inflation (right). We can see that there is a wide dispersion of outcomes, but generally speaking, real GDP is expected to be lower than baseline and inflation is expected to be higher than baseline, driven by transition risk.
For acute physical risk, we leaned heavily on our partnership with Woodwell Climate Research Center to devise a forward-looking model that integrates physical-risk projections and the likely impact on GDP. We viewed the challenge as analogous to measuring corporate credit losses, in that there are both losses and recoveries to consider. The process we arrived at involved developing country-level assumptions for future extreme climate events (e.g., a 1-in-100-year precipitation event), the associated damages and recoveries, and the potential impact on real GDP.
In our new paper, Integrating climate change into capital market assumptions: our approach and findings, we offer a deeper dive on our climate-aware CMAs, including our fundamental asset-class methodology. We also compare the results with our regular CMAs and highlight several findings, including the greater impact on equity (versus fixed income) and on emerging market equity (versus developed). Ultimately, we think integrating climate-related inputs into a CMA methodology is likely to alter asset allocations. Even if the changes in CMAs are modest, they may impact rank-order preferences for asset classes and the relative attractiveness of risk assets themselves. One final point: climate change is dynamic and uncertain, and asset owners will need to periodically revisit their asset mixes as policy evolves and climate scenarios unfold.
URL References
Related Insights
Stay up to date with the latest market insights and our point of view.
European elections: all change for equity investors?
Macro Strategist Nicolas Wylenzek discusses how the elections for the European Parliament could herald significant change, with major implications for European equity investors.
Small-cap stocks: Watching for mean reversion, technology diffusion, and the next inflection point
Our experts discuss factors that could help small-cap stocks rebound and the search for winners in this inefficient segment of the market.
Beyond the hype: finding AI’s long-term winners
Our expert argues that a long-term mindset based on deep research can help to uncover evolving AI investment opportunities amid the hype.
Bonds in brief: making sense of the macro — April issue
What's driving global bond markets and what are the investment implications? Read the April issue of "Bonds in brief" for Wellington Investment Director Marco Giordano's monthly assessment of risks and opportunities within bond markets.
Weekly Market Update
What do you need to know about the markets this week? Tune in to Paul Skinner's weekly market update for the lowdown on where the markets are and what investors should keep their eye on this week.
Exploring active opportunities amid continued regime change
Head of Multi-Asset Strategy, APAC, Nick Samouilhan outlines why today's environment of dispersion, divergence and disruption offers potentially compelling opportunities for active investors.
Powell back to waiting on inflation data
Our expert's key takeaways from the May FOMC meeting.
2023 Sustainability Report
We appreciate the opportunity to share our approach to advancing sustainable practices across our investment, client, and infrastructure platforms.
Impact investing in emerging markets: Growing opportunities, shifting challenges
Members of our impact bond team discuss their evolving emerging markets opportunity set and the importance of a bottom-up approach to value creation.
Can hedge funds play the role?
How should investors select the most suitable types of hedge funds for specific roles? Members of our Investment Strategy & Solutions Group offer a simple and intuitive framework that can help.
Three ways social considerations can enhance portfolios
Four leading Wellington equity and fixed income experts explore three ways social considerations can enhance portfolios.
URL References
Related Insights