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- Title
Climate Portfolio Alignment and Temperature Scores.
- Authors
de Franco, Carmine; Nicolle, Johann; Lan-Anh Tran
- Abstract
In this article, the authors show, first with a toy model and then with actual data, how the aggregation method for a portfolio's temperature scores heavily determines and shapes its exposures. By using the default choice for portfolio optimization, weighted-average temperature (WAT), one could severely underestimate the portfolio's temperature alignment. Under WAT, business as usual would already be aligned with the Paris Agreement. We compare the WAT approach with the carbon-weighted temperature (CWT) score, a different aggregation metric that increases the sensitivity of the portfolio's total temperature to companies with high climate-related risks. By design, the authors' CWT is heavily dependent on the most impactful companies and sectors in the portfolio. Under CWT, the major stock market indexes would show an implied temperature higher than 3°C, which is more consistent with empirical findings from influential research on climate. The authors also show that under WAT, each sector's contribution to the total temperature fairly matches its weight in the portfolio, which is not consistent with empirical evidence that climate impacts are not equally spread across the economy. On the contrary, under CWT, the authors show how the contribution of a few sectors (energy, utilities, materials) is between 70% and 80% of the total implied temperature. Choosing WAT instead of CTW could have implications that go beyond the simple arithmetic of temperature alignment. Indeed, as the portfolio's temperature decreases with the weights of high-impact sectors under WAT, one could build 1.5°C-or 2°C-aligned portfolios simply by removing companies that have direct exposure to climate risks. Unfortunately, such portfolios will do close to nothing to help move capital toward companies and activities that are part of the broad solution to the climate change challenge to be faced in the coming decades.
- Publication
Journal of Impact & ESG Investing, 2023, Vol 4, Issue 2, p66
- ISSN
2693-1982
- Publication type
Academic Journal
- DOI
10.3905/jesg.2023.1.083