A climate-aware total portfolio framework

We develop a climate-aware total portfolio framework incorporating climate risk across a broad universe of asset classes - stocks, bonds, and alternatives, including corporate bonds, commodities, listed real estate, and hedge funds - alongside a comprehensive set of low-carbon assets. The framework captures dynamic interactions between asset prices and global warming risks through a vector autoregression (VAR) model, embedding forward-looking climate scenarios into portfolio returns via a stylized return-generation model that explicitly accounts for uncertainty in future climate pathways. Our results reveal that low-carbon assets exhibit a resilient - and in some cases positive - relationship with temperature change, while most traditional assets are adversely affected by warming risk. Examining an optimistic trajectory implied by the VAR model and a pessimistic trajectory derived from the DICE model, we find that under the pessimistic scenario, a substantial reallocation toward low-carbon assets emerges - suggesting that for long-horizon investors, sustainable investing is not merely an ethical choice, but an optimal portfolio strategy.