Viewpoints

Managing Climate Risk in Investment Portfolios: PIMCO’s Approach

We designed seven proprietary tools to assess, manage, and help mitigate climate-related risks in our portfolios, and to harness potential opportunities in the evolving market landscape.

Climate change is likely to be a disruptive force in the global economy over the very long term. Average temperatures around the globe continue to rise, and the consensus across the scientific community is that human activity is the driving force – largely in the form of greenhouse gas emissions (source: Intergovernmental Panel on Climate Change (IPCC)). Many investors, companies, organizations, and nations are starting to hear the alarms about climate-related threats and seeing dramatic, sometimes devastating impact on economies and markets in addition to communities and ecosystems.

In 2018 alone, there were notable instances when markets felt the consequences of deadly wildfires, hurricanes, typhoons, and other climate-related catastrophes across the globe. Climate change can affect investments across asset classes, including a wide range of fixed income securities: corporate credit, mortgage-backed securities, sovereigns, and municipalities.

Therefore, as a steward of our clients’ assets, PIMCO believes it is critical to incorporate climate risk evaluations in our investment decisions. As active asset managers, we must be forward-looking – considering material risks on the horizon, not just those immediately affecting issuers. And in our view, those long-term risks are significant, systemic, and rising. Even while many dedicated groups work hard to limit climate change and mitigate or adapt to its effects, the window of opportunity to prevent lasting global damage may be closing, according to recent reports from the IPCC and the Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services (IPBES).

As risks mount, many issuers around the world are shifting from climate awareness to action, giving rise to new investment opportunities. Many investors are monitoring government responses to climate risks in the form of regulation, carbon taxes, and public investment, as well as shifts in consumer sentiment and business models. We expect this will change the investment landscape: The transition away from fossil fuels toward clean energy, for example, could transform the global economy and create significant investment opportunities. ESG-focused (environmental, social, and governance) investment approaches as well as broader portfolios can be positioned to harness these kinds of potential opportunities. Fixed income markets, in our view, may present a diverse array of sustainable investment options in the years to come. We assess both top-down macro trends and bottom-up ideas amid the evolving environment of climate risk.

Managing Climate Risk in Investment Portfolios: PIMCO’s Approach

PIMCO’s climate risk analysis framework

PIMCO’s climate research is led by credit analysts – the experts in their market sectors – who build on the structure of our broader ESG specialist desk for coordination and consistency. Climate risk now features in our proprietary ESG scores for the issuers we evaluate. In this way, PIMCO leverages the expertise of our analyst teams, while harmonizing climate risk analysis across asset classes and sectors. Our ESG scores inform broad PIMCO portfolios, not only ESG-focused portfolios with specific sustainability objectives.

To help analysts evaluate climate risk, PIMCO’s ESG specialists designed seven proprietary tools (see Figure 2), drawing on our decades of experience in fixed income analysis. The insights these tools provide are intended to help portfolio managers to better manage and mitigate climate-related credit risks and align ESG dedicated portfolios with the Paris Agreement targets – as always, working within specific portfolio objectives and guidelines. (The Paris Agreement is the global accord to limit the global temperature rise by year 2100 to 1.5°C – 2°C above pre-industrial levels.)

These analytical frameworks serve the whole spectrum of PIMCO’s ESG-specific and broader investment strategies and enable PIMCO’s ESG dedicated strategies to align with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD).

PIMCO’s seven climate tools: risk analysis in practice

Managing Climate Risk in Investment Portfolios: PIMCO’s Approach

Tool #1: Climate Macro Tracker

To ensure we have a robust long-term, top-down perspective on climate risk, PIMCO designed and developed our own Climate Macro Tracker (Tool #1). This tool monitors the broad momentum in climate change across key themes and scenarios, and measures the gap between the real-world metrics and global climate goals.

Currently, our macro tracker (see Figure 3) tells us that despite progress in some areas, broad global trends remain deeply concerning as the concentration of carbon dioxide (CO2) in the atmosphere continues to rise and is projected to lead to a temperature rise exceeding 3˚C by 2100 at this pace.

From a macro perspective, climate-related risks to the global economy are real and alarming. By some estimates, climate change could result in multitrillions of dollars of economic losses and a large negative impact on global GDP, in addition to the profound impact on communities and ecosystems (sources: OECD, CRO Forum, among others). Along with the challenges and risks, we also keep an eye on climate-related macro trends (regulations, energy, and technology, for example) likely to create business and investment opportunities.

Managing Climate Risk in Investment Portfolios: PIMCO’s Approach

Tool #2: Portfolio Climate Risk Heat Map

The pace of change is swift: Risks and opportunities related to climate change may materialize in unexpected ways. The impact on financial markets and bond prices may be abrupt and sudden, and as investors we must stay vigilant and flexible.

When evaluating climate-related risks and opportunities of specific sectors and issuers, we begin with two broad categories: 1) transition risks (e.g., tighter regulations on carbon emissions) and 2) physical risks (e.g., how the rising intensity and frequency of extreme weather events affects critical assets and natural resources used by the issuer) – see Figure 4.

Managing Climate Risk in Investment Portfolios: PIMCO’s Approach

PIMCO’s Tool #2, the Portfolio Climate Risk Heat Map, gives a high-level overview of exposure to climate risk (both transition and physical) among relevant sectors and assets. Figure 5 illustrates a “heat map” of select corporate sectors’ exposure, from low risk (green) to high risk (red), along with examples of relevant climate risks within each sector. Looking across the range of risks in a portfolio helps a portfolio manager assess and fine-tune exposures.

Managing Climate Risk in Investment Portfolios: PIMCO’s Approach

Tool #3: Issuer Climate Risk Score

PIMCO’s Issuer Climate Risk Score (Tool #3) assesses climate change risks for a wide range of relevant sectors and issuers. In the auto sector, for example, we explore climate change in the broader context of stricter legislation covering air pollution, while for the food and agriculture sectors, carbon risks should not, in our view, be disentangled from steps taken by issuers to mitigate the underlying commodities’ water or land footprint.

As with the heat map (Tool #2), the climate risk scores are divided into transition risks and physical risks. Our transition risk scores are typically favorable for the most carbon-efficient issuers and for those proactively seeking to align with the Paris Agreement in light of their respective business and geographical contexts. The transition risk score draws on metrics such as the issuer’s current and future carbon emissions using a lifecycle approach and recognized methods such as the science-based target approach, as well as business mix outlook (e.g., revenues, capital expenditures) considering technology pathways enabling issuers to align with the limits on rising temperatures.

Case study A: Energy (corporate credit)

For instance, PIMCO’s fundamental analysis of credits in the energy sector closely examines companies’ exposure to different types of energy sources, environmental and regulatory risks to the business activities, the relative cost positions of companies and their commitments, and steps taken to diversify into low-carbon sources of energy.

Ultimately, we look to map the likely winners and losers, notably based on scenario analysis and the extent to which long-term climate risks are reflected in our credit views and bond prices, and, if they are not, what this could mean for issuers’ credit quality considering bond characteristics (e.g., duration) over time.

Case study B: Real estate and mortgage-backed securities

In general, we believe the real estate sector needs to step up its efforts to improve buildings’ energy efficiency via more extensive upgrades of existing properties. Our environmental assessment for real estate examines practices in terms of green buildings and like-for-like carbon emissions, energy intensity reductions, and reduction of physical risks.

Looking across subsectors, our climate scores for REITs (real estate investment trusts) suggest that malls and offices are generally the most advanced in their practices and trajectories. And within mortgage-backed securities (MBS), we see geographical diversity as a key edge against material losses prompted by extreme weather events.

Case study C: Sovereign credit

Our sovereign credit climate score comprises a host of metrics that capture each country’s exposure and readiness to cope with climate change, connecting environmental with economic variables. Energy-intensive and fossil-fuel-dependent economies are much more likely to be affected by the transition to cleaner energy, but the pace will be key to each sovereign’s ability to manage the transition risks, as well as their savings buffer and reforms to shore up growth from other sectors. Conversely, rising temperatures and physical climate risks are likely to disproportionally affect the credit risk of developed and smaller countries.

Case study D: Municipal bonds

PIMCO’s municipal climate score considers a variety of factors to assess the economic vulnerability associated with climate risks, as well as the ability and willingness of states and local governments to adapt and achieve sustainable initiatives.

In the municipal market, high physical risks are generally concentrated around coastal communities with elevated incidents of storms and flooding, while high transition risks reflect economies with larger exposures to the energy and mining sectors.

Tool #4: Portfolio Energy and Technology Mix Measured Against the Paris Agreement

We complement our sector-based and bottom-up analysis of carbon risks with a portfolio tool that monitors the carbon impact of corporate holdings across a portfolio and seeks ways to mitigate emissions beyond exclusion screens. PIMCO’s Energy and Technology mix compared with the Paris Agreement (Tool #4) assesses the average technology and energy mix of a portfolio compared with global energy scenarios modeled by the International Energy Agency (IEA), including the potential impact of green bonds, considering their specific environmental features and issuer-level data. Figure 6 compares PIMCO’s ESG portfolio with current and future IEA estimates of Paris-aligned portfolios.

Managing Climate Risk in Investment Portfolios: PIMCO’s Approach

Tool #5: Portfolio Carbon Intensity Analysis

Moreover, as part of PIMCO’s Portfolio Carbon Intensity Analysis (Tool #5), we have developed high-level portfolio screens that allow comparison of carbon intensity of different portfolios and benchmarks based on the weighted average sum of both direct greenhouse gas emissions and greenhouse gas emissions due to purchases of electricity, heating, and cooling (i.e., scope 1 + scope 2 emissions in tonnes of carbon dioxide equivalent, or tCO2e / revenues in USD (weighted based on percentage of market value)) – see Figure 7.

Managing Climate Risk in Investment Portfolios: PIMCO’s Approach

Tool #6: Green Bonds Score

Green bonds and other debt instruments geared toward sustainability are proliferating in the global marketplace. Our ESG process integrates analysis of debt instruments geared toward climate solutions via our proprietary Green Bonds Score (Tool #6).

We assess green bond instruments both prior to and after issuance, mapping them across a spectrum based on strategic fit, potential impact, red flags, and reporting, resulting in PIMCO’s impact score for green, social, or SDG bonds. PIMCO’s green bond scores aid the investment process and security selection, allowing for stronger differentiation among green bond issuers and frameworks.

Tool #7: Engagement With Issuers on Climate Change

We engage with bond issuers both to bolster their Paris Agreement alignment and to help them improve their management of the underlying credit risks, moving from awareness to readiness, and ultimately commitment (Tool #7: PIMCO’s Engagement With Issuers on Climate Change). To learn more about how we use issuer engagement as a tool to actively monitor and encourage issuers’ disclosure and strategy on climate change, please see our latest ESG Investing Report.

PIMCO is part of Climate Action 100+, an investor-led climate engagement coalition that works with selected issuers among the largest carbon emitters in a broad range of sectors.

Key takeaways

As we discuss in PIMCO’s latest Secular Outlook, we believe the disruptive impact of climate change on human lives, economic activity, and financial markets will create many winners and losers, which will require active management of credit and other risks. Climate-related shocks could become more frequent and severe, and have the potential to wreak havoc with economic activity and inflation, and thus could make it more difficult for investors and central banks to separate the noise from the signal.

As an active investment manager, PIMCO seeks to understand and act on that signal – to proactively assess and manage the risks and opportunities created or compounded by climate change. Our proprietary tools and methods are designed to help investors navigate an uncertain future in an evolving global economy.

Learn more about our innovative approach to ESG investing in fixed income markets.

READ HERE

Download our latest ESG Investing Report, featuring detailed insights into trends and tools for sustainable investing.

READ HERE
The Author

Samuel Mary

ESG Research Analyst

Christian Schuetz

Credit Analyst, European Utilities and Energy

Olivia A. Albrecht

Executive Office, ESG Business Strategy

Related

Disclosures

London
PIMCO Europe Ltd
11 Baker Street
London W1U 3AH, England
+44 (0) 20 3640 1000

Milan
PIMCO Europe Ltd - Italy
Corso Matteotti 8
20121 Milan, Italy
+39 02 9475 5400

Munich
PIMCO Deutschland GmbH
Seidlstraße 24-24a
80335 Munich, Germany
+49 (0) 89 26209 6000

Zurich
PIMCO (Schweiz) GmbH
Brandschenkestrasse 41
8002 Zurich, Switzerland
Tel: + 41 44 512 49 10


PIMCO Europe Ltd (Company No. 2604517) and PIMCO Europe Ltd - Italy (Company No. 07533910969) are authorised and regulated by the Financial Conduct Authority (25 The North Colonnade, Canary Wharf, London E14 5HS) in the UK. The Italy branch is additionally regulated by the CONSOB in accordance with Article 27 of the Italian Consolidated Financial Act. PIMCO Europe Ltd services and products are available only to professional clients as defined in the Financial Conduct Authority’s Handbook and are not available to individual investors, who should not rely on this communication. | PIMCO Deutschland GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany) and PIMCO Deutschland GmbH Swedish Branch (SCRO Reg. No. 516410-9190) are  authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 32 of the German Banking Act (KWG). The Swedish Branch is additionally supervised by the Swedish Financial Supervisory Authority (Finansinspektionen) in accordance with Chapter 25 Sections 12-14 of the Swedish Securities Markets Act. he services provided by PIMCO Deutschland GmbH are available only to professional clients as defined in Section 31a para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication. | PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2), Brandschenkestrasse 41, 8002 Zurich, Switzerland, Tel: + 41 44 512 49 10. The services and products provided by PIMCO (Schweiz) GmbH are not available to individual investors, who should not rely on this communication but contact their financial adviser.

Socially responsible investing is qualitative and subjective by nature, and there is no guarantee that the criteria utilized, or judgment exercised, by PIMCO will reflect the beliefs or values of any one particular investor. Information regarding responsible practices is obtained through voluntary or third-party reporting, which may not be accurate or complete, and PIMCO is dependent on such information to evaluate a company’s commitment to, or implementation of, responsible practices. Socially responsible norms differ by region. There is no assurance that the socially responsible investing strategy and techniques employed will be successful. Past performance is not a guarantee or reliable indicator of future results.

All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Sovereign securities are generally backed by the issuing government. Obligations of U.S. government agencies and authorities are supported by varying degrees, but are generally not backed by the full faith of the U.S. government. Portfolios that invest in such securities are not guaranteed and will fluctuate in value. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Mortgage- and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and while generally supported by a government, government-agency or private guarantor, there is no assurance that the guarantor will meet its obligations. REITs are subject to risk, such as poor performance by the manager, adverse changes to tax laws or failure to qualify for tax-free pass-through of income. Income from municipal bonds for U.S. investors is exempt from federal and may be subject to state and local taxes and at times the alternative minimum tax. Investors should consult their investment professional prior to making an investment decision.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice. Strategy availability may be limited to certain investment vehicles; not all investment vehicles may be available to all investors. Please contact your PIMCO representative for more information.

This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

PIMCO provides services only to qualified institutions and investors. This is not an offer to any person in any jurisdiction where unlawful or unauthorized. | Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660 is regulated by the United States Securities and Exchange Commission. | PIMCO Europe Ltd (Company No. 2604517) and PIMCO Europe Ltd - Italy (Company No. 07533910969) are authorised and regulated by the Financial Conduct Authority (12 Endeavour Square, London E20 1JN) in the UK. The Italy branch is additionally regulated by the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act. PIMCO Europe Ltd services are available only to professional clients as defined in the Financial Conduct Authority’s Handbook and are not available to individual investors, who should not rely on this communication. | PIMCO Deutschland GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany), PIMCO Deutschland GmbH Italian Branch (Company No. 10005170963), PIMCO Deutschland GmbH Spanish Branch (N.I.F. W2765338E) and PIMCO Deutschland GmbH Swedish Branch (SCRO Reg. No. 516410-9190) are authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 32 of the German Banking Act (KWG). The Italian Branch, Spanish Branch and Swedish Branch are additionally supervised by the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act, the Comisión Nacional del Mercado de Valores (CNMV) in accordance with obligations stipulated in articles 168 and 203 to 224, as well as obligations contained in Tile V, Section I of the Law on the Securities Market (LSM) and in articles 111, 114 and 117 of Royal Decree 217/2008 and the Swedish Financial Supervisory Authority (Finansinspektionen) in accordance with Chapter 25 Sections 12-14 of the Swedish Securities Markets Act, respectively. The services provided by PIMCO Deutschland GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication. | PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2), Brandschenkestrasse 41, 8002 Zurich, Switzerland, Tel: + 41 44 512 49 10. The services provided by PIMCO (Schweiz) GmbH are not available to individual investors, who should not rely on this communication but contact their financial adviser. | PIMCO Asia Pte Ltd (Registration No. 199804652K) is regulated by the Monetary Authority of Singapore as a holder of a capital markets services licence and an exempt financial adviser. The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Asia Limited is licensed by the Securities and Futures Commission for Types 1, 4 and 9 regulated activities under the Securities and Futures Ordinance. The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Australia Pty Ltd ABN 54 084 280 508, AFSL 246862 (PIMCO Australia). This publication has been prepared without taking into account the objectives, financial situation or needs of investors. Before making an investment decision, investors should obtain professional advice and consider whether the information contained herein is appropriate having regard to their objectives, financial situation and needs. | PIMCO Japan Ltd, Financial Instruments Business Registration Number is Director of Kanto Local Finance Bureau (Financial Instruments Firm) No. 382. PIMCO Japan Ltd is a member of Japan Investment Advisers Association and The Investment Trusts Association, Japan. All investments contain risk. There is no guarantee that the principal amount of the investment will be preserved, or that a certain return will be realized; the investment could suffer a loss. All profits and losses incur to the investor. The amounts, maximum amounts and calculation methodologies of each type of fee and expense and their total amounts will vary depending on the investment strategy, the status of investment performance, period of management and outstanding balance of assets and thus such fees and expenses cannot be set forth herein. | PIMCO Taiwan Limited is managed and operated independently. The reference number of business license of the company approved by the competent authority is (107) FSC SICE Reg. No.001. 40F., No.68, Sec. 5, Zhongxiao E. Rd., Xinyi Dist., Taipei City 110, Taiwan (R.O.C.), Tel: +886 (02) 8729-5500. | PIMCO Canada Corp. (199 Bay Street, Suite 2050, Commerce Court Station, P.O. Box 363, Toronto, ON, M5L 1G2) services and products may only be available in certain provinces or territories of Canada and only through dealers authorized for that purpose. | PIMCO Latin America Av. Brigadeiro Faria Lima 3477, Torre A, 5° andar São Paulo, Brazil 04538-133. | No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. ©2019, PIMCO.

CMR2019-0711-405221