If climate change represents a major investment risk, should investors seek minimal deviations from a misaligned market? We explore the trade-offs between tracking error, forward and backward-looking climate metrics in the context of portfolio alignment.
Executive Summary
- Investors who believe climate risks are significant and systemic should not aspire to doggedly track a misaligned market.
- With simplicity at their heart, win-win approaches that keep both carbon and tracking error low at an aggregate level can be misleading upon closer inspection.
- Investors wanting the highest impact should put climate science at the heart of portfolio construction and allocate. capital to companies, across all sectors, that are on target to reduce emissions in line with science-based emission pathways.
- With data and analytics fast improving, tools such as climate alignment can help investors bring climate modelling to the heart of portfolio construction.
- The transition will not be linear. An active approach can allow investors more freedom to engage with and distinguish between companies that are already part of the solution, those that are credibly transitioning, and those that risk becoming obsolete.
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