TY - JOUR T1 - Optimizing Portfolios across Risk, Return, and Climate JF - The Journal of Impact and ESG Investing SP - 115 LP - 131 DO - 10.3905/jesg.2020.1.1.115 VL - 1 IS - 1 AU - Benoît Mercereau AU - Lionel Melin Y1 - 2020/08/31 UR - https://pm-research.com/content/1/1/115.abstract N2 - Climate concerns have grown dramatically. Investment tools to fight climate change are still lacking, though. We develop portfolio optimizers that minimize climate impact while maximizing expected returns and minimizing risk. Global equity investors can lower their portfolio’s climate alignment temperature to 2.5°C without hurting its Sharpe ratio. Lowering its temperature further is more costly. Investors willing to forego 1pp in expected returns to shave 1°C off their portfolio would invest in firms aligned with a sub 2°C climate scenario on average. Hence, investors factoring climate alignment in would benefit “colder” assets and hurt “hotter” ones. In practice, asset allocators could use three-dimensional optimizers to design the best risk, return, and climate impact trade-off for each client. Being able to diversify across asset classes means that the trade-off between risk-adjusted returns and climate alignment is moderate.TOPICS: ESG investing, portfolio theory, portfolio constructionKey Findings• Equity investors can lower their portfolio’s climate alignment temperature to 2.5°C without hurting risk-adjusted returns. Lowering temperature further is progressively more costly.• Asset allocators can lower their portfolio’s temperature at a moderate cost to risk-adjusted returns. Our optimizer allows each investor to find his or her best risk, return, and climate impact trade-off.• Rising climate awareness may benefit colder stocks and hurt hotter ones. Investors caring slightly more about climate implies large portfolio changes. Moreover, equity investors can lower portfolio temperature by half a degree celcius without hurting Sharpe ratios—leaving hotter stocks particularly vulnerable. ER -