In the past, discussions on carbon risk would typically involve scientific arguments regarding climate change and whether existing evidence supported market participant action for carbon-awareness investing. In recent years, climate change policy and knowledge have progressed to the point where many large institutions across the globe have already begun to incorporate varying degrees of carbon risk integration into their investment process.
Concurrent to the low-carbon investing trend has been the adoption of factor-based asset allocation by institutional investors. Institutional investors who are implementing factor-based investing into their core equity allocation and who wish to align their entire investment process with low-carbon initiatives may need a total portfolio management approach, in which metrics related to carbon risk are integrated with signals from traditional risk factors. As such, there is a clear need in the market for studies that examine the impact of carbon risk integration with traditional factor portfolios.
Therefore, the debate at this juncture centers more on how imminently carbon risk is priced and thus to what degree market participants should position their existing portfolios. As a starting point for carbon-awareness investing, knowing the carbon footprint of a given portfolio is required. However, carbon footprint measures only part of the carbon-pricing risk and is not forward looking in providing a complete estimate of carbon risk exposure.