Portfolio design: Use impact investments to minimize climate risks
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Generate impact and returns. With sustainable portfolio design.

Climate risks are becoming more relevant in a wide range of areas, and the investment world is no exception. A portfolio design that aims to reduce our carbon footprint offers attractive opportunities, particularly for ultra-high net worth individuals. Thanks to impact investing and sustainable investments, they can cultivate new return opportunities while doing their part to combat climate change.

Reducing the risks of climate change with sustainable investments

Climate change is one of the largest systemic challenges of our time, and for investors it poses tangible valuation risks. However, as the world relentlessly moves to a low-emissions economy, significant revenue opportunities are emerging.

This means that ultra-high net worth investors in particular must consider how to align their portfolios to a low-carbon future. In fact, "decarbonizing" their portfolio allows them not only to reduce their exposure to CO2 risks but also to generate attractive returns, play an active role in managing climate change, and drive progress in ESG-related themes (ESG = environmental, social, governance – a standard for evaluating sustainable investments).

Assessing the climate risks of a portfolio design

The first step is to determine how much an existing portfolio is exposed to the risks of climate change. Comparing the portfolio's CO2 footprint with a benchmark provides a rough estimate of the consequences that higher CO2 costs, for instance, would have on performance. Forward-looking approaches that consider a company's emissions as only part of the problem also allow for a more holistic view of whether a portfolio is compatible with global decarbonization. Finally, newer methods such as the Science-Based Targets Initiative (SBTi), the Paris Agreement Capital Transition Assessment (PACTA) and the Transition Pathway Initiative provide guidelines for evaluating the extent of a portfolio's focus on the target of a maximum global warming of 1.5°C.

A systematic evaluation of the portfolio using a combination of these three methods can indicate which companies are on the right track in terms of climate risks, and which are lagging behind. This enables investors to identify new options for effective reallocation of their portfolios.

Missed earnings opportunities in portfolios that do not account for decarbonization

Constructing a portfolio that neglects decarbonization can have negative consequences

Percentage of earnings at risk from rising carbon costs
Sources: Schroders, Datastream.
The value of the portfolio is based on a hypothetical strategy comprising the five largest funds managed by Schroders. Calculated using components as of May 2017. For illustrative purposes only.

Reducing the CO2 intensity of a portfolio with sustainable investments

A risk assessment can help investors align their portfolios more closely to climate goals. These days, there are alternatives for nearly all asset classes that can be used to greatly improve the carbon footprint with a similar risk/return profile. If a portfolio is aligned to a maximum temperature increase of 1.5°C, the total emissions must also be greatly reduced as well. Over the long term, this can impact sector weighting and portfolio focus areas.

To reduce the CO2 intensity of a portfolio, the strategic reallocation should focus on companies who lead the pack in climate progress while moving away from companies who lag behind. This could mean completely excluding certain sectors whose future viability is limited in a low-carbon scenario, or by replacing bonds from a company with a negative climate rating in favor of "green" bonds with a similar credit rating, for instance.

Integrating climate change into the investment process through portfolio design

When considering the likely impact of climate change, investors must remember one thing: Every sector, regardless of country, is facing unique challenges. Technological disruption will affect a number of sectors in different phases. While some companies do generate a high volume of emissions, they manufacture products that will help us transition to a low-carbon economy, which means opportunities for financial returns. Because no two companies, sectors or regions will be impacted to the same extent, these factors cannot be generalized and must be evaluated in detail on an individual basis.

Making sure that the fundamental analysis considers climate change along with the main opportunities and risks, and replacing traditional strategies with those that integrate the primary climate aspects into the investment process, will pay off.

Achieve maximum effect with impact investments

Direct investments in climate solutions also offer ultra-high net worth individuals the opportunity to counter climate change effectively, and to use their portfolios to make a quantifiable contribution to managing the climate crisis. Supporting innovative companies during their growth phase or projects in emerging countries with additional capital can have a profound impact. With a view to greater portfolio diversification, it is also worthwhile considering investments in areas that are adapting to the consequences of climate change, such as climate-smart agriculture or flood proofing.

Therefore, with regard to long-term effects, the portfolio's high-impact segment should focus on financing climate solutions in private market strategies that have specific key figures to measure the climate impact, for instance in such asset classes as venture capital, private equity, private debt, "green" properties and unlisted infrastructure investments. In liquid markets, too, ultra-high net worth individuals and portfolio managers can use active ownership to make a difference, thereby advancing corporate climate measures using business-based arguments.

Benefit from mandate solutions for sustainable investments

Ultra-high net worth individuals in particular can benefit from the exclusive services of our mandates in the area of ESG and climate focus. Credit Suisse offers a structured investment process and access to many years of expertise, along with the global skills of Credit Suisse in the areas of ESG and sustainability. Specialized portfolio managers apply a strategy tailored to individual needs, which minimizes expenses and allows investors to maximize their impact and financial returns.

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