A blueprint for building climate-aware multi-asset portfolios

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The views expressed are those of the authors 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. 

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Our Investment Strategy & Solutions Group, 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. We think it can help asset owners seeking to holistically incorporate climate objectives into their portfolios via strategic asset allocation (SAA), as well as those who simply want to better understand the various climate-aware investment options and their potential trade-offs.

The framework consists of three “pillars.” The first focuses on incorporating climate-related inputs (including transition risks and physical risks) into the capital market assumptions (CMAs) that underpin SAA decisions. The second is a climate-aware SAA approach, which entails adding relevant climate metrics to the asset allocation optimization process. And the third pillar is implementation — the choice of specific climate-aware building blocks and strategies to express the desired asset allocation.

We touched on the importance of implementation in our last paper, but here we take a deeper dive, sharing our insights on:

  • Key features of climate investing, including a long time horizon and an evolving opportunity set
  • Asset-class considerations such as the choice between public and private assets and issues around data availability
  • Pros and cons of different approaches in the climate investing universe
  • The active versus passive decision, including portfolio construction and manager evaluation

Ultimately, we think the implementation process requires a detailed “blueprint” to guide critical investment decisions. To help, we wrap up with a checklist of seven steps that climate-aware asset owners can use to create their own blueprints.

Key features of climate investing

As a starting point, we identified during our research several important aspects of climate investing that asset owners should consider:

A long time horizon — While some effects of climate change are playing out in real time, they are magnified over longer horizons. Indeed, climate change is often referred to as a “tragedy of the horizon” in that its most catastrophic effects are expected to be felt over periods much longer than a typical investment horizon. Earlier action on climate-change mitigation and adaptation can reduce the impact, as suggested by early and late transition scenarios designed by the Network for Greening the Financial System (NGFS), but overall, there is an argument for deeper alignment with longer-horizon strategies within traditional asset classes (e.g., buy and maintain credit or long-term-focused equity strategies), as well as alternative asset classes such as private equity and infrastructure.

The long time horizon also means that: 1) integrating climate into portfolios is likely to be a more natural fit for asset owners with extended horizons, and 2) asset owners who do want to take a more climate-aware approach will likely be better served by applying an extended horizon to their investment decisions.

A dynamic opportunity set — The scale of change and time needed for the energy transition (the shift from fossil fuels to renewable energy sources) means that asset owners need to be prepared for the opportunity set to evolve. For example, traditional sector/industry classifications may not be as useful in the future. Companies likely to fit in a climate-aware portfolio will span a variety of sectors (e.g., industrials, technology, utilities, consumer staples) and the list will change over time, requiring a multisector opportunity set that can do the same.

On a related note, “problem” sectors may also be part of the opportunity set if an asset owner embraces the reality of a nuanced transition process. Coal is the prime example: Investor dumping of coal assets has driven many of the industry’s assets into the private sector, where they are run with less oversight and where the new owners may be incentivized to squeeze out every penny of value, even if that means maximizing the assets’ productive lives. But for the energy transition to succeed, it may be necessary for public companies to own these assets and help shift to lower-carbon solutions over time.

A scientific perspective — We think it is critical to incorporate scientific research, as reflected in our approach to climate scenario analysis (using integrated assessment modeling) and collaboration with Woodwell Climate Research Center, as well as the work of many other organizations such as the UN’s Intergovernmental Panel on Climate Change (IPCC). Scientific research is, in our view, crucial for identifying investment materiality. It is also important to be comfortable with a greater range of model uncertainty when linking scientific and economic scenarios.

Multiple approaches to climate risk and opportunities — Asset owners need to be comfortable with the fact that not all managers approach climate investing with the same tool kit — i.e., some lean into engagement, while others focus on “climate solutions” (companies that generate revenue from products/services that help others reduce emissions or improve resilience). The universe includes strategies that integrate climate more deeply and those that are broadly climate aware. From a portfolio diversification perspective, we think it is important to consider both strategies that seek resilience to physical climate change and strategies focused on climate mitigation, as focusing only on the latter would mean leaving out a significant piece of the climate-change challenge and opportunity. We compare different climate investing approaches later in the paper.

Diversification opportunities and measures — We believe diversification should be achieved across a variety of dimensions in the climate space. It is possible, for example, to segment exposure based on the role played by these investments — decarbonizing assets, solutions for mitigation, or solutions focused on resilience. Asset owners can also consider the factor footprint of their climate exposure and opportunities to balance it directly through portfolio construction or indirectly through allocations across the climate opportunity set.

Climate investments cut across asset classes, including equities, fixed income, real estate, real assets, and private assets. It may pay for asset owners to deploy active budget in less efficient areas, with decisions driven by measures such as dispersion of climate metrics or an understanding of where gaps in analyst coverage exist.

Asset class considerations

Next, we touch on several key asset class considerations that asset owners will need to factor into their implementation decisions.

Active vs passive
As noted earlier, there are a variety of climate investing strategies, including both active and passive strategies. One of the advantages of active strategies, in our view, is that managers can take multiple approaches in pursuit of the investment objectives: engaging with companies, reducing a portfolio’s weighted average carbon intensity (WACI) or the implied temperature rise (ITR)1, or investing in climate solutions, for example. In addition, active managers can use detailed research to help uncover value or find inconsistencies in reported data.

Passive allocations can also address climate across multiple dimensions (e.g., through the use of Paris-aligned benchmarks2), but this approach will be less nuanced, less able to evolve, and potentially more exclusionary. For example, passive funds tracking a Paris-aligned benchmark typically aim to minimize WACI or ITR. Since the indices themselves are designed to minimize tracking error versus a traditional index, this more statistical approach may miss out on opportunities that active managers can pursue.

We delve deeper into the active/passive decision later in the paper.

Public vs private assets
While the bulk of the climate investing universe has historically been focused on the public market, private asset approaches have grown meaningfully in size and maturity. We think private equity can be an effective way to tap into innovation. Here, climate investments can be either early stage and more “science focused” (e.g., on technologies that have yet to scale, such as direct air carbon capture) or later-stage, more proven technologies.

It is worth noting that climate-related metrics for private assets are currently fairly limited compared with the public market, so it can be challenging to quantify or assess the climate intensity or positive impact of private investment approaches. One solution could be to use public assets as a proxy for private assets. In addition, when possible, the disclosure of climate goals should be an objective of engagement when investing in private assets, especially given that the ownership structure provides the investor more influence (often, information may be available but not disclosed). Forthcoming climate disclosure rules in the European Union (EU), Australia, and California require disclosure from companies — listed or private — that meet certain revenue and other thresholds, which could improve data availability. At Wellington, we have been involved in the ESG Data Convergence Initiative (EDCI), which seeks to create a set of comparable and meaningful ESG data (including in climate) from private companies.

Sovereign bonds
One of the biggest data gaps exists within sovereign bonds, where asset owners and managers have historically not applied climate investment frameworks. Here, the issue isn’t one of disclosure, as both production- and consumption-based emissions metrics are widely reported, as is other data such as that on fossil fuel exports. However, investment frameworks are at an earlier point in their evolution, with initiatives such as the Assessing Sovereign Climate-related Opportunities and Risks (ASCOR) Project aiming to develop assessment methodologies for sovereign bonds. At Wellington, we have a framework for assessing sovereigns on climate metrics that considers developed and emerging markets separately and assigns a greater weight to transition metrics for developed markets. For emerging markets, physical risks are key. We also engage with Woodwell Climate Research Center on regular climate “deep dives” on particular countries to enhance our understanding of country-specific challenges and opportunities.

Other tools can also be leveraged for assessing sovereign portfolios. For instance, as noted earlier, the NGFS publishes climate transition and physical risk scenarios. They could be used to evaluate countries’ current policies and climate-action plans (Nationally Determined Contributions or NDCs3), as well as their impact on macro variables such as GDP and inflation, and on what achieving carbon neutrality by 2050 could mean for country fundamentals.

Reconciling data issues and data availability
In our last paper, we took an in-depth look at the addition of climate-related metrics to the strategic asset allocation optimization process and the ways in which that process can help with multiple objectives — for instance, a better WACI and a better ITR. But what about trade-offs within asset classes? Following are a few thoughts on navigating the data limitations discussed above:

Private assets — When data for the optimization process is lacking, we think the answer is not to penalize the asset class. Rather than reduce or avoid allocations to private assets on the basis of data availability, other levers can be used at the implementation stage (e.g., engagement).

Public assets — For public assets, where data comparability can be an issue, the optimization process can be conducted at the gross asset class level — e.g., improve the ITRs separately within each asset class. We find this is generally possible within equities and credit, while for sovereigns, a lack of ITR data may require a different approach — looking instead at sovereigns’ current policies or NDCs, for example. However, as noted in our last paper, this can result in high turnover and deviations from the benchmark.

Company emissions — With respect to data availability for company emissions, Scope 1 and 2 data is generally readily available, but access is more challenging as the data becomes increasingly nuanced.4 With Scope 3 data and physical risk data, it becomes necessary to rely more on company reports, and issues of comparability can emerge. As noted, ITRs can be useful in this exercise and are forward-looking, but they may also rely on more opaque calculations from third-party providers. Other forward-looking data considerations include whether a company has committed to decarbonization targets under the Science Based Targets initiative (SBTi) and whether those targets have been validated.

Impact metrics — We have an internal impact measurement framework that seeks to provide as much consistency as possible in each sector, but again, the information companies provide is not always comparable. As a result, it may be necessary to use “adjacent” KPIs, such as data on the percentage reduction in energy use (versus emissions avoided). Based on our experience, it is imperative to avoid false precision — i.e., don’t make assumptions if it’s not necessary.

Physical risk — Physical risk is challenging to evaluate, but there are tools that can help. As an example, our Climate Research Team has created a tool that uses location data for more than 10,000 public companies and several thousand securities. The team has evaluated the physical risk of about 92% and 71% of the market value of the S&P 500 and MSCI ACWI, respectively, as of the end of 2023.

For sovereigns, the NGFS scenarios, which have been enhanced with more robust modeling of chronic and acute physical risk, can be leveraged. They may enable a holistic view of a portfolio should the net-zero targets fall short and physical climate-change risks accelerate. From an alpha potential standpoint, we think it will be important to be exposed to countries with the ability to adapt and with the lowest impact on GDP from climate change.

Data availability for different issuers — To provide a sense of the tools and data available across issuers, Figure 1 shows some of the key carbon footprint metrics discussed for a number of equity and fixed income indices. Not surprisingly, there is less coverage for the high-yield fixed income universe, where issuers are further down the market-cap spectrum. The table also highlights the different WACI methodologies investors should be aware of when looking at corporate versus sovereign indices. Within the sovereign space, the choice of the production method or the consumption method of calculating carbon intensity can influence the output and portfolio-level exposures. Being aware of the choices and assumptions behind each metric used to assess a carbon footprint is important, especially if the metrics will be used to inform allocation decisions or as an input to any optimization process.

Figure 1
Carbon footprint matrics

A closer look at the climate investing universe: Comparing approaches

Climate investing approaches can vary a great deal and it is essential for asset owners to understand how well each will align with their specific objectives. To help, we consider the pros and cons of some of the most common approaches used by asset owners or active (and, in some cases, passive) managers to build climate-aware portfolios. Managers may use more than one approach in a single portfolio, and we think asset owners may want to do the same.

Negative screening — Excluding securities that do not meet desired climate-based criteria. Implemented at the issuer, sector, industry, or asset class level, or based on a materiality threshold (e.g., coal cannot be >x% of total revenue).


  • Most immediate portfolio impact as assets are deemed out of scope at the outset
  • Transparent criteria


  • Reduction in the investable universe and can result in high tracking error
  • Limits financing for entities moving toward improvement but still scoring poorly on climate metrics; can reduce alpha potential and diversification
  • Inconsistent measurement across asset classes

Positive screening — Actively targeting companies that are climate leaders as measured by the climate goals of the asset owner.


  • Focused on companies well positioned for the future
  • Direct correlation to positive sustainability impact


  • Reduction in the investable universe
  • Companies headed in the right direction but not there yet will be missed; can reduce alpha potential and diversification
  • Inconsistent measurement across asset classes

Thematic investing — Investing in companies that may benefit from a specific climate-related theme (e.g., the energy transition) due to their products and services.


  • Alpha derives from higher pricing power and revenue potential as markets grow
  • May be less correlated to the economic cycle given its longer-term nature
  • An active approach within themes may allow for more factor balance in portfolio construction


  • Benchmarking can be challenging
  • Themes can take time to play out
  • Mapping individual companies to themes can be challenging

Investing in the transition — Investing in transition leaders within high-emitting sectors, usually paired with engagement.


  • A more forward-thinking approach as business models shift toward being more sustainable
  • Targets real-world impact and direction of change, given that high-emissions companies are crucial to the transition
  • Can have more balance in factors (e.g., in value) or sectors, providing diversification


  • Payback periods can be long
  • Can initially make portfolios look less green
  • Engagement may not work as desired

Impact investing — Investing to achieve specific, measurable climate mitigation and adaptation outcomes.


  • Explicit link to climate objectives
  • Can be combined with broader environmental and social impact variables
  • Targets climate solutions with tangible results


  • Smaller investable asset universe could limit alpha potential
  • Disclosure and comparability of impact metrics can be a challenge
  • Tends to be more small- and mid-cap biased

Green and labeled bonds — Bonds that have dedicated use of issuance proceeds for climate or other environmental/social projects.


  • Specific link to environmental activities and projects
  • Market has matured significantly


  • Hard to identify and track tangible impact unless the bond is “sustainability linked” with specific KPIs
  • Often trade at a lower yield for the same issuer
  • Not clear that they should carry lower climate risk than the issuer’s other bonds

The active/passive decision: Portfolio biases, constraints, and manager evaluation

Passive approaches to incorporating climate considerations usually include carbon tilting (e.g., toward industries less exposed to climate risk), approaches focused on companies in a Paris-aligned benchmark, and the use of exclusionary/negative screens. Active approaches may emphasize decarbonization of the total portfolio, climate solutions, physical versus transition risk, mitigation versus adaptation/resilience, Paris/net-zero alignment, engagement, or other objectives, and usually include some form of negative screening. Whether the desired implementation approach is passive or active, the portfolio construction process should take into account style and sector biases associated with the investable universe.

Biases of passive and active approaches
To illustrate the potential impact of these biases, we conducted analysis using an equity style factor lens. We started with our Fundamental Factor Team’s market environments framework analysis in Figure 2, which shows that Paris-aligned benchmarks have carried a negative value bias and a pro-growth bias during months when the value style factor led and/or months when the growth style factor lagged the broader market. This footprint tended to hold across regions. It intuitively makes sense, given that “climate solutions” companies are often earlier-stage, growth-oriented companies, as well as the fact that growth will tend to have less exposure to traditionally capex-heavy businesses facing greater uncertainty around their successful transition to a low-carbon world.

Figure 2
Value and growth biasis

Balancing style risk may be easier through an active implementation approach, given the potential for a more diverse style footprint thanks to the heterogeneity of approaches to integrating climate considerations. In Figure 3, we compared the value and growth exposures of a set of our firm’s own active climate-aware strategies and several Paris-aligned indices (relative to their respective core regional benchmarks) using a Barra model.

Figure 3
Seeking style diversity through active management

Achieving sector neutrality might be challenging regardless of the chosen implementation, as both active and passive (Paris-aligned) approaches we looked at had common sector biases — most notably, no ownership within energy and a meaningful overweight to industrials (many companies producing climate solutions or actively decarbonizing are in the industrials sector, which is energy intensive and under pressure to change). Commonly used sector and industry classifications may fall short of capturing the climate opportunity set, as noted earlier, but they are still important to consider from a traditional risk and diversification standpoint.

The trade-off between strict climate criteria and diversification
Climate integration approaches at both the strategy and multi-asset portfolio level often leverage some form of screening or quantitative constraints to define the opportunity set. Given the rising demand for asset owners to demonstrate net-zero alignment, such an approach may seem attractive considering its apparent simplicity and immediate alignment outcome. However, we caution against integrating onerous constraints without fully understanding how the chosen approach changes the breadth and footprint of the opportunity set. To illustrate this point, we looked at three constraint scenarios going from strict to more pragmatic (inclusive) criteria for global equities, emerging market equities, and global credit (proxied with the MSCI ACWI, MSCI EM Index, and Global Agg Corporate Index, respectively). The constraint criteria we considered are focused on Scope 1, 2, and 3 emissions and are outlined below:

  1. ITR <=1.5°C (lower bound of the Paris Agreement)
  2. ITR <=2°C (upper bound of the Paris Agreement)
  3. ITR <=2°C or targeting at least a 90% reduction in carbon intensity by 2050 (allowing for issuers who have signaled meaningful decarbonization goals)

In Figure 4, we show the amount of industry group market value (% MV) that is captured given the three different sets of constraints for the global equity universe (MSCI ACWI). Based on our constraint criteria, the industries with the lowest % MV include those that are critical for the energy transition (energy, autos, materials, utilities, and transportation). An active approach that centers on companies undertaking credible transitions in challenged industries may help address lower exposure to these sectors.

Figure 4
Testing the impact of climate constraints on global equities

The industries with the lowest % MV coverage were largely similar for the global credit universe. However, global credit showed lower % MV alignment with the constraint criteria than global equity (Figure 5). It is also notable that emerging market equities show the lowest % MV aligned, regardless of the constraint scenario. This suggests that the process of evaluating emerging market exposure within the context of net-zero alignment could be particularly challenging and may call for a more nuanced approach. Lower % MV alignment (such as in the strictest scenario of ITR <=1.5°C) also implies higher tracking error relative to core benchmarks, and potentially less diversification given the reduced breadth of industries and number of issuers that satisfy the constraint.

Figure 5
The impact of climate constraints on global credit, global equities, and EM equities

Active manager evaluation
The fact that active managers use various strategies to account for climate risks and opportunities makes it difficult to evaluate them with a single metric such as ITR. Instead, the evaluation process should be consistent with the manager’s focus and explicit objectives. Like asset owners, active managers will have a range of objectives and are unlikely to focus solely on climate risk and opportunity (their approach may, for example, depend on the extent to which they believe there is a return or alpha trade-off that comes with targeting a particular carbon impact).

The manager evaluation process should lean on both historical and forward-looking metrics, with the latter likely being of greater importance but also subject to greater (model or realization) uncertainty. Historical metrics can include absolute carbon emissions and emissions intensity, along with their realized trajectory; realized progress on Paris-specific targets and net-zero goals; and the presence of an engagement philosophy and process. Forward-looking indicators can include the presence of interim and long-term SBTi commitments, ITR objectives, and key physical and transition risk exposures (where data is available).

Active management and the pursuit of ITR targets
Given that passive Paris-aligned indices are constructed based on optimization to an ITR target or other specific criteria, it’s not surprising that they offer the most attractive ITR improvement relative to a core benchmark. We believe that an active strategy lineup could provide comparable trade-offs with the added benefit of engagement with underlying issuers that show a willingness to transition but have reasonable constraints (often related to costs or technical issues) that have kept them from publishing more ambitious targets to date.

Unsurprisingly, with respect to ITRs, and given the point made earlier about the potential benefits of a multidimensional approach, active strategies focused on resilience or with a broader or more “pragmatic” climate focus may tend to have higher ITRs (Figure 6). Notably, the absolute point-in-time portfolio ITR score may be less useful than the overall direction of change toward alignment and the way in which progress is measured over time.

Figure 6
ITRs of active strategies can vary depending on the approach

An argument can also be made that when real-world outcomes are desired with respect to high-emitting sectors, continued engagement enabled by active strategies could offer better outcomes than the outright divestment/exclusion pressure associated with low-carbon passive approaches.

Overall, we believe that while there is likely to be some trade-off between meeting climate targets and achieving diversification, an active, diversified set of approaches may be better suited to the pursuit of climate objectives while also allowing for a reduction in portfolio biases.

A note on fixed income and passive indices
We also carried out an analysis of passive indices of corporate bonds, focusing on metrics such as duration exposure, yield levels, and sector biases relative to core equivalents. We found comparable yield levels across most indices, but lower coupon rates for nearly all the Paris-aligned indices we analyzed. The Paris-aligned US high-yield index had more spread exposure (duration times spread) than the core equivalent, and accordingly, higher spread (option-adjusted spread). Paris-aligned indices for US and UK investment-grade credit tended to have a shorter-duration bias, driven by lower exposure to 10- to 30-year segments. Sector biases were meaningful, including underweights to energy and overweights to REITs and technology.

Bringing it all together: Creating an implementation blueprint

We think best practice is to formulate a robust implementation strategy that uses various approaches. The first step in designing such a “blueprint” is to establish an organizational philosophy that is consistent across functions (avoid silos). Determine which element of climate investing is most critical and balance a reduction in poor climate performers with dedicated allocations to climate solutions and a robust process for engagement. Make decisions at the asset class level (e.g., are commodities part of the opportunity set?) and the security level.

To help with the blueprint process, we’ve outlined seven steps we think asset owners should consider. Given the complexity of some of these steps, asset owners will likely want to partner with experienced asset managers and other subject matter experts when applying them. We also think it is important to recognize that this process will be a blend of art and science; that is, some decisions will be data-driven and their outcomes measurable, while others will be driven by judgment, experience, and some degree of trial and error.

Step 1: Create a comprehensive strategy for transition risks and opportunities
1. Formulate an emissions target framework

Plan for emissions calculations and emissions scopes to be included (e.g., a timeline for phasing in Scope 3)

  • Which asset classes will be included?
  • Which method of calculation will be used?
  • Consider using commonly accepted approaches (e.g., those established by the Partnership for Carbon Accounting Financials) that do not differentiate between equity and debt in the attribution of financed emissions (instead, financed emissions should be attributed in proportion to their share of enterprise value).
  • How will assets without emissions information be factored in?
  • Consider starting to measure avoided emissions (Scope 4) in your portfolio. While a singular accepted methodology does not yet exist, disclosure that transparently explains the calculation methodology can provide context for investments in areas such as climate solutions.

Balance the long-term emissions reduction goal (e.g., net zero by 2050) with interim targets (e.g., every five years)

2. Determine an appropriate implementation approach to pursue emissions targets

We think asset owners should consider a blend of these approaches:

  • Negative screening — Selectively exclude companies with high emissions and poor prospects of participating in the transition. (We believe this should be a last resort and prefer engagement.)
  • Positive screening — Target companies with credible transition pathways, targets validated by the SBTi, or lower current emissions. Asset owners could also consider integrating benchmarks aligned with the Paris Agreement.
  • Transition investing — If the direction of change and real-world impact is the focus, investing in transition leaders within high-emitting sectors may be a credible approach. It may also help diversify portfolios from a sector or factor standpoint. If necessary, this allocation can be carved out, so it doesn’t weigh on portfolio emissions targets or ITRs.
  • Thematic/impact investing — Dedicate a set percentage of assets, likely growing over time, to climate solutions to the challenges of the energy transition.
  • Sovereigns and other fixed income opportunities — Set an approach for integrating climate into sovereign evaluation frameworks, with appropriate nuances for emerging markets. Consider a selective allocation to green and labeled bonds where the investment opportunity is attractive.

Step 2: Create a strategy for physical climate risks and opportunities
1. Evaluate existing exposure to physical risks

  • Identify assets with material exposure to geographies with risk factors (e.g., asset-intensive businesses or regional concentration of revenue).
  • Pay particular attention to long-lived or illiquid assets.
  • Map event probabilities for physical risk based on the locations of a portfolio’s largest exposures.

2. Determine whether existing investments compensate for risks from the increased frequency and severity of acute climate events, and consider other implementation approaches

  • Negative screening — Selectively exclude companies with substantial exposure to physical risks (e.g., illiquid assets in natural-disaster-prone areas) or where a return premium doesn’t exist.
  • Positive screening — Target assets that are in more favorable locations and/or have begun spending on adaptation to protect themselves moving forward.
  • Thematic/impact investing — Invest in assets where revenues are directly correlated to an increase in physical risk probability (e.g., dredging, air conditioning, water treatment). Target companies providing climate adaptation solutions, including infrastructure and real estate assets.

Step 3: Integrate top-down approaches

  • Allocate to low-emitting assets (e.g., Paris-aligned strategies) and transitioning assets.
  • Avoid high-emitting assets (e.g., exclude brown assets and sectors/industries).
  • Allocate to climate solutions as an asset class (dedicated public and private exposures).
  • Integrate top-down and bottom-up approaches; e.g., use more active risk on security selection in sectors and countries facing higher climate risk and where a broad, dispersed opportunity set is available.

Step 4: Establish criteria for special cases of active management
In addition to the ideas in Steps 1 and 2 above for selecting different investment approaches, we think asset owners should consider the following:

1. Carving out specific allocations in private assets

  • Private companies may continue to play a critical role in both the energy transition and climate-change adaptation.
  • Companies earlier in their life cycles (VC/early stage) are often industry disruptors and may be on the cutting edge in providing climate solutions.

2. Looking into impact approaches, which may be effective in this area

  • A key characteristic of impact investing is the concept of intentionality (an intentional desire to contribute to a measurable social or environmental benefit), so consider whether this is important.
  • Gauge how climate interacts with other measures of impact in a broader portfolio’s objectives. (Learn more in our collection of impact investing content.)

3. Determining an approach to sovereigns

  • Parameters and weights should differentiate between emerging and developed markets, considering “fair share” (the notion set out in the Paris Agreement of putting more of the burden of achieving climate goals on developed markets) and various development constraints faced by emerging markets, and avoiding screening out those markets.
  • Pay attention to both a country’s exposure to physical risks and its capacity for adaptation/resilience.
  • An active approach may be particularly effective in evaluating emerging market sovereigns from a climate perspective, given the constraints noted earlier (Figure 5)
  • Determine whether climate-risk analysis will be factored into a portfolio’s broader mosaic for understanding country risk or more specifically used for idea generation in the pursuit of alpha.

Step 5: Design an engagement strategy

  • Instead of defaulting to divestment or exclusion, consider creating a robust engagement framework aimed at enabling skilled portfolio managers to seek better future outcomes from asset issuers. By providing funding to entities who are in the early stages of the energy transition, asset owners can aid in the transition and potentially find alpha in underappreciated parts of the capital markets.
  • Determine whether sovereign engagement should be a focus for portfolio managers.

Step 6: Understand how incorporating climate impacts other portfolio objectives

  • Asset owners will likely incorporate multiple climate constraints and objectives. However, there will be trade-offs. For example, incorporating physical risks may dilute a portfolio-level implied temperature rise (ITR) metric (read more on ITR in our previous paper). Some of this can be overcome through portfolio construction.
  • Spend some time identifying and addressing unwanted factor biases arising from climate implementation. For example, an asset owner might address an unwanted growth bias by adding to strategies or sectors that offset it.
  • Consider how climate implementation impacts diversification; e.g., from a sector or region perspective.
  • Consider ways to address other investment risks while not sacrificing climate goals; e.g., incorporating strategies that invest in the commodities that will enable and support the energy transition, which may help with inflation mitigation.

Step 7: Create a feedback loop to incorporate the latest science, data, and calculation methodologies

  • Climate-related metrics and calculations are evolving at a rapid rate. As more data becomes available, asset owners should revisit which assets are included in calculations.
  • Over time, assess issuers that have not made any effort to improve positioning for a warming world and consider divestment.
  • Use scenario analysis to determine how the existing asset mix may perform depending on different transition pathways and levels of physical risk (e.g., frequency and severity of acute physical risk events).


We’ll wrap up with a few final thoughts. First, while our climate-aware framework for multi-asset portfolios touches on a number of critical topics, including capital market assumptions and strategic asset allocation, we believe decisions about implementation may ultimately play the most significant role in helping asset owners achieve climate goals. Second, we have designed our framework to reflect the nature of multi-asset investing, which requires a process that is flexible enough to address asset owners’ differing objectives and concerns. Some asset owners, for instance, may want to target a level of carbon reduction versus a reference benchmark, while others may want to pursue broader climate awareness through the choice of specific investment strategies to express the asset allocation. Our team’s three-pillar framework is flexible and robust enough to address all of these possibilities and many more. We would welcome the opportunity to discuss it in greater detail.

1For more on WACI, ITR, and other climate metrics, see our paper, “Designing a climate-aware strategic asset allocation.” | 2Benchmarks aligned with the provisions of the 2015 Paris Climate Agreement, which calls for pursuing efforts to limit warming to 1.5°C. | 3NDCs detail efforts by each country to reduce emissions and adapt to the impact of climate change. The Paris Agreement requires each country to prepare, communicate, and maintain NDCs that it intends to achieve. | 4Scope 1 includes direct emissions from a company’s owned or controlled sources. Scope 2 includes indirect emissions from purchased or acquired energy. Scope 3 includes all indirect emissions that occur in the value chain of a reporting company.

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Archived pieces remain available on the site. Please consider the publish date while reading these older pieces.

Why climate change matters in private markets

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Archived pieces remain available on the site. Please consider the publish date while reading these older pieces.
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Archived pieces remain available on the site. Please consider the publish date while reading these older pieces.

Why sustainable food systems matter to investors

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Archived pieces remain available on the site. Please consider the publish date while reading these older pieces.
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Archived pieces remain available on the site. Please consider the publish date while reading these older pieces.

When extreme weather becomes the norm: what’s next for climate investors?

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Archived pieces remain available on the site. Please consider the publish date while reading these older pieces.

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