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Record-setting heat, droughts, floods, wildfires, and hurricanes have brought massive, costly destruction and business disruptions. They have also spurred the momentum behind decarbonization and net-zero objectives around the world. Against this backdrop, asset owners are increasingly engaged in addressing the investment implications of climate change. To help, our Investment Strategy Team, in partnership with our Climate Research and ESG Research teams, has developed a framework for integrating climate change and its capital-market effects into multi-asset portfolios.
One of the “pillars” of our framework is our climate-aware strategic asset allocation (SAA) approach. We think it can be of use to asset owners who are actively seeking to incorporate climate objectives into their portfolios via SAA, as well as those who want to better understand the trade-offs they may face if they decide to specifically incorporate these objectives in their investment policy.
Our framework consists of three pillars. The first, which we wrote about previously, is focused on incorporating climate-related inputs (including both transition and physical risks) into our capital market assumptions (CMAs). The second pillar is our climate-aware SAA approach — that is, adding relevant climate metrics to our asset allocation optimization process. By quantifying the climate risk embedded in various potential allocations, for example, we can undertake analysis around climate change similar to our approach to other risk exposures, such as portfolio volatility or maximum expected drawdown. The third pillar of our framework is implementation — the choice of specific climate-aware building blocks and strategies to express the desired asset allocation.
In designing our climate-aware SAA approach, we conducted in-depth research to select a suitable forward-looking climate variable — implied temperature rise (ITR) — for our optimization process (while acknowledging that there are other valid metrics that may be useful for an asset owner’s specific needs). We then identified data sources for different asset classes and tested the limits of climate constraints within an SAA process. The details of this research are discussed here.
We found that a number of challenges and trade-offs can crop up when pursuing climate goals (e.g., alignment with a specific temperature-based target like ITR) using a purely top-down approach. For example, a desired asset allocation may not be viable at a certain level of ITR, given that a majority of companies in the investable universe are not yet aligned with established temperature targets (although we expect ITRs to come down over time as more companies set targets, resulting in a larger investable universe). In addition, a top-down approach can result in significant changes in a portfolio’s underlying assets — changes that may amount to a poor trade-off for the resulting ITR reduction. Finally, asset owners should beware of sector and regional concentration risks that can result from optimization exercises.
Based on our analysis, we think it will generally be critical to pair a top-down optimization process (e.g., using ITRs) with building-block implementation in order to minimize portfolio changes and pursue specific climate-change objectives (e.g., targeting groups of companies that have credible transition plans or offer climate solutions). We would highlight a number of top-down and bottom-up ideas for asset owners to consider:
Finally, whatever the approach to implementation, key performance indicators should be monitored over time. Not only can this help to create a clear connection between the asset owner’s investments and broader climate initiatives, but it will also provide reporting transparency that can ensure accountability and foster dialogue about trade-offs. For more on our research, read our paper, Designing a climate-aware strategic asset allocation.
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Beyond China: what does the rest of the EM equity world have to offer?
For investors contemplating a separate allocation to EM ex-China equities, members of our iStrat Team share their research on the composition of the opportunity set, the growing divergence in the behavior of EM ex-China equities and Chinese equities, and the long-term market outlook.
You snooze, you may lose: The case for bonds
There are signs the Federal Reserve's rate-hiking cycle may be nearing an end, but some uncertainty remains. With that in mind, Multi-Asset Strategist Nanette Abuhoff Jacobson considers the timing of a move from cash to bonds.
Deglobalisation and divergence: opportunity or threat?
John Butler and Supriya Menon discuss the drivers underpinning growing macroeconomic divergence and deglobalisation and what it may mean for asset allocators.
Is bad news for the economy actually good news for markets?
While it has taken longer than expected, higher interest rates are starting to take their toll on the global economy and the "bad news is good news" market narrative could be changing. Members of our Investment Strategy team offer their macro and market outlook, including their latest views on equities, bonds, and commodities.
The “cleanest dirty shirt” now has too many stains
Fixed Income Portfolio Manager posits that US fiscal profligacy will change the game for asset allocators.
Income investing in multi-asset portfolios: Tipping the balance in your favour
Income can play a crucial role in the pursuit of investment objectives over time, but research from our iStrat Team argues for a balanced approach to asset allocation decisions given the potential trade-offs between income and capital return, risk, and portfolio diversification.
Role, risk, and residual alpha: A framework for manager research
With many asset owners revisiting their strategic asset allocation and considering changes in their investment line-up, Director of Manager Research Kat Price and Head of Multi-Asset Strategy Adam Berger offer their views on manager selection best practices.
A test for the global economy
What are the similarities and differences between the US regional banking crisis and 2008's global financial crisis? How likely is a recession? Should investors be focusing on value or growth? In this podcast, Macro Strategist Nanette Abuhoff Jacobson shares her interpretation of where the economy is headed, outlining where the risks and opportunities may lie for investors in the next 12 months.
Multi-Asset Outlook: A recession is looming…or is it?
The economy has largely shrugged off the banking crisis and other concerns this year, while riding positive sentiment driven by AI enthusiasm and a possible soft landing. Members of our Investment Strategy team offer their macro and market outlook for the second half of the year, including their latest views on equities, bonds, and commodities.
How to weather the storm: A roadmap for more resilient portfolios
As we face a new era of elevated market and cycle volatility, Co-Head of Investment Strategy Natasha Brook-Walters assesses how asset owners can ensure that their portfolios are up for the challenge.
How a thematic approach can help harness change within portfolios
Multi-Asset Strategist Supriya Menon and Investment Director Andrew Sharp-Paul discuss why a thematic approach can help harness change within portfolios against a structurally different macroeconomic backdrop.