To protect their portfolio from climate risks and to favor a more climate-friendly development, many investors take measures. In doing so, sufficient diversification should be ensured.
Against the backdrop of the Paris Climate Agreement, many investors are taking measures to eliminate climate risks: they are exercising their voting rights, joining investor initiatives, refurbishing their real estate, financing infrastructure in the field of renewable energies or generally changing their portfolio composition. Investors are often faced with the question of how much they should intervene in the investment process to take climate risks into account and how much they should influence the portfolio composition. «Depending on the design of the interventions in the portfolio composition, diversification can suffer», warn the experts from the consulting firm PPCmetrics. They cite two examples to illustrate that this aspect should not be ignored.
Climate-compatible investment funds have lower climate risks
Economists Marco Ceccarelli, Stefano Ramelli and Alexander Wagner studied over 10'000 investment products in 2021 and found that «climate-compatible» investment funds had lower climate risks compared to conventional investment instruments. Climate-compatible products tend to generate excess returns when new negative information on climate change impacts became known. At the same time, however, the authors demonstrated that, on average, climate-compatible investment products were associated with higher unsystematic risks than products without a climate focus. «This means that the intended climate risk reduction led to less diversification and thus higher overall risk. Diversification is particularly important when unforeseen events occur, such as an increase in energy prices», explains Cyrill Rütsche, Senior Consultant focusing on ESG at PPCmetrics.
Volatility of the highly focused Renixx Index is high
The experts cite a real-world example to confirm the observation of risk increase: Over the past decade (2013-2022), the volatility of the highly focused Renixx Index has been roughly twice that of the broadly diversified MSCI World equity index. The Renixx Index tracks the value performance of the 30 largest companies in the renewable energy sector and thus contains substantial concentration risks.
Sufficient diversification is central
The experts at PPCmetrics note that investors have many tools at their disposal to take climate risks and opportunities into account in the investment process. The key is not only to consider climate risks, but also to ensure sufficient diversification across asset classes, markets, countries, and sectors. Silvia Rudigier, Partner and Head ESG, affirms: «This can be achieved through targeted and coordinated measures, such as moderate portfolio interventions and stewardship activities, i.e. exerting influence by exercising voting rights, investor initiatives and the like. »
The source of the text is an article published in «Portfolio Institutionell» in April 2023.
