Factor Investing in Paris: Managing Climate Change Risk in Portfolio Construction

Journal of Investment Management, Forthcoming

23 Pages Posted: 29 Apr 2022

See all articles by Janina Kolle

Janina Kolle

Invesco

Harald Lohre

Robeco Quantitative Investments; Lancaster University Management School

Erhard Radatz

Invesco

Carsten Rother

Invesco; University of Hamburg

Date Written: March 30, 2022

Abstract

The 2015 Paris Agreement is a landmark in limiting emissions and targeting global warming well below 2, preferably 1.5, degrees Celsius compared to pre-industrial levels. In this light, we investigate how to efficiently construct equity portfolios that help mitigating climate change risk but at the same time enable harvesting well-established return drivers such as value, momentum or quality. A pure reduction in greenhouse gas intensity or a divestment from fossil sectors is not necessarily leading to a better temperature alignment of a portfolio. Given the limited set of temperature-aligned assets, keeping the average temperature increase below 2 degrees comes with considerable active risks. To this end, we propose a net zero portfolio construction framework that brings temperature alignment together with a reduction in carbon intensity, while harvesting equity factor premia.

Keywords: Factor Investing, Portfolio Optimization, Sustainable Investments, Net Zero Framework, Paris Alignment

JEL Classification: G11, C61, D81

Suggested Citation

Kolle, Janina and Lohre, Harald and Radatz, Erhard and Rother, Carsten, Factor Investing in Paris: Managing Climate Change Risk in Portfolio Construction (March 30, 2022). Journal of Investment Management, Forthcoming, Available at SSRN: https://ssrn.com/abstract=4071422

Janina Kolle

Invesco ( email )

An der Welle 5
Frankfurt am Main, 60322
Germany

Harald Lohre

Robeco Quantitative Investments ( email )

Weena 850
Rotterdam, 3011 AG
Netherlands

Lancaster University Management School

Bailrigg
Lancaster LA1 4YX
United Kingdom

HOME PAGE: http://www.lancaster.ac.uk/lums/people/harald-lohre

Erhard Radatz

Invesco ( email )

An der Welle 5
Frankfurt am Main, 60322
Germany

Carsten Rother (Contact Author)

Invesco ( email )

An der Welle 5
Frankfurt am Main, 60322
Germany

University of Hamburg ( email )

Allende-Platz 1
Hamburg, 20146
Germany

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