Strategic Asset Allocation for a +1.5°C World: a proposed framework

What you need to know

Climate change is material risk - Global warming poses long-term physical risks as the climate changes, as well as nearer term risks as the energy sector shifts from fossil fuels to low-carbon alternatives. Climate science and the Intergovernmental Panel on Climate Change (IPCC)
have shed light on the global carbon efficiency gains needed to keep the temperature rise by the end of the century to a maximum of 1.5°C compared to the pre-industrial era. The Paris Agreement implies that annual global net CO2 emissions will have to be at zero by 2050 and halvedby 2030. This effort is being distributed differently among industries and countries. 

A major challenge for long-term investors - Investors are being incentivized to integrate climate into their allocation decisions. This is happening on several fronts:

• Perceptions of investment risks are shifting rapidly to include climate change as a leading concern. In the latest Global Risks Perception Survey, environmental concerns dominate the list of major long-term risks identified among members of the World Economic Forum’s multi- stakeholder community.
• There is a growing weight of evidence that climate change is financially material. A study by consultants Mercer (1) showed that a scenario keeping global warming to below +2°C is the likely best outcome to investors, compared to +3°C (current Paris Agreement pledges) and +4°C scenarios (business as usual) from a long-term investor perspective. Looking ahead to the half century, a +4°C scenario would leave a developed markets equity portfolio down by -5.6% and diversified portfolios down more than 0.10% each year up to 2100 compared to a +2°C scenario.
• Regulation and prudential oversight is incorporating global warming concerns in ways that will affect institutional long-term investors. For example, we can highlight regulatory discussion in Europe around the integration of a green or a brown factor into capital requirements.

AXA IM’s approach to Climate Change Strategic Asset Allocation (2)  - Climate Change is not impacting investment assets in an equal manner. In this research, we present an approach based on current carbon-intensity data and a climate-related typology of assets to enable a strategic asset allocation exercise consistent with a +1.5°C trajectory. Our simulations show that incorporating into the SAA the +1.5°C objective of halving carbon emissions by 2030 could be achieved without deteriorating risks-adjusted returns.

Limitations remain – The lack of data and standards to measure climate impacts remains an obstacle to allowing investors to align to a +1.5°C trajectory. To ensure reasonable investment exposure to sectors at stake in the transition, the following considerations are necessary:

• Metrics used to materialize climate impacts need to be enriched and  more forward looking. In particular, carbon performance measures should cover the 3 scopes of CO2 emissions, and new climate metrics such as the green share and investment temperature should be integrated into the analysis.
• SAA frameworks and market indices need to be further adapted to better reflect various levels of an asset’s maturity in the transition. Through its alignment investment principles, AXA IM proposes an introductory framework for further research to better align SAA with the +1.5°C trajectory.