Climate aware startegic asset allocation

27 June 2022

The need to take climate change into account as a structural factor of performance

Academic research, as well as the lessons of experience, demonstrate that long-term asset allocation is the main source of performance, far ahead of tactical allocation or investment selection. However, with the problem of global warming linked to greenhouse gas emissions, the concept of “Tragedy of the horizon” has highlighted the necessary consideration in the construction of portfolio of a very long duration event, of the order of 80 years, time necessary for the associated damage to materialize fully. Simultaneously, the community of central banks acknowledges that climate change poses potentially systemic risks to financial stability that could materialize in “green swan” events.

Consequently, traditional backward-looking probabilistic approaches would not be able to assess climate-related risks properly. Historical data are certainly not sufficient to define a long-term asset allocation. They are even partially counterproductive, because they are supported by irrelevant economic and monetary fundamentals. Alternative approaches based on a green taxonomy may also prove insufficient as they only offer a static view of the reality they depict. New forward-looking approaches are therefore needed. Such scenario-based methodologies seek to set up plausible hypotheses for the future without attributing a probability of occurrence to each of them.

Strategic asset allocation must take into account the transition of economies to a decarbonized economy, the only scenario capable of avoiding devastating global warming, by positioning itself on investments that generate performance and lower risk. But other, less positive, scenarios have to be considered too. This is the subject that the Climate Aware Strategic Allocation aims to cover. In addition, this transition may be induced and accelerated by promoting the financing of traditional industries, the development of transitional facilitating activities or of disruptive innovations. This is the subject of Investing in Climate by selecting ad-hoc investments within each asset class once the allocation has been completed.

In more details, Climate Aware Strategic Allocation is based on three pillars: expected returns derived from a consistent economic scenario, risk measures, volatility and correlations, and an algorithm for optimizing risk-adjusted returns. The idea is to use an essentially forward-looking scenario-based approach to implement the strategic asset allocation.

The scenarios translate the more or less intense efforts of the global economy to mitigate carbon emissions and adapt economic structures to warming while taking into consideration productivity, demographic trends, the relative energy intensity of the economy and the carbon content of energy production. The economic and scientific community agrees on five so-called Shared Socioeconomic Pathways (SSP), determined by the degree of mitigation and adaptation. They range from a virtuous scenario corresponding to the compliance with the United Nations Sustainable Development Goals in the context of enhanced international cooperation to an extreme scenario of regional rivalries abandoning any ambition in the field of climate. The purpose of this study is to deduce what strategic asset allocation is optimal for each SSP.

Les sites du groupe
My bookmarks

Pins are saved using cookies. Deleting them from your browser will delete your preferences.

La Française Group provides access to the expertise of a number of asset management companies around the world. To provide you with the most relevant information, we have developed an interface to present the full range of products available for your investor profile and country of residence.
Please indicate your profile
1
Country
2
Language
3
Profile
Your country of residence
Your language
Your profile
<p class="new-disclaimer__legal-notice">Before consulting this website, for your protection and in your interest, please read the “<a href="en/legal-notice/" target="_blank">disclaimer</a>” and “<a href="en/regulatory-information/" target="_blank">current regulations</a>” carefully. This information explains certain legal and regulatory restrictions which apply to individual and professional investors according to local law. By accessing this site, in my non-professional or professional capacity, I acknowledge that I have read and accept the terms and conditions of use. Pursuant to the application of the European Markets in Financial Instruments Directive (“MiFID”), please state to which category of investor you belong&nbsp;:</p>
<p class="new-disclaimer__legal-notice">Before consulting this website, for your protection and in your interest, please read the “<a href="en/legal-notice/" target="_blank">disclaimer</a>” and “<a href="en/regulatory-information/" target="_blank">current regulations</a>” carefully. This information explains certain legal and regulatory restrictions which apply to individual and professional investors according to local law. By accessing this site, in my non-professional or professional capacity, I acknowledge that I have read and accept the terms and conditions of use. Pursuant to the application of the European Markets in Financial Instruments Directive (“MiFID”), please state to which category of investor you belong&nbsp;:</p>