As climate risk climbs the agenda for pension funds, insurers and asset managers, investors are seeking to embed climate considerations across the entire investment process, from capital market assumptions and strategic asset allocation through to benchmark design and security selection.
According to research from Ortec Finance, a key question now confronts investment teams: should climate risk be tackled top-down or bottom-up?
Ortec Finance argues that the answer starts with understanding the nature of the risk itself. Climate change is systemic, shaping macroeconomic conditions, market dynamics and valuations across every sector, asset class and geography, which makes it hard to diversify away through conventional allocation strategies.
At the same time, its impacts are unevenly spread. No asset is immune, but exposure differs across regions, across sectors, and even within the same sector in different locations. Each holding therefore carries a unique climate risk profile, driven by its particular mix of business activities, geographic footprint and management’s sustainability strategy.
Top-down climate scenario analysis examines how systemic physical, transition and market risks evolve under different climate pathways, quantifying their effect on economies, sectors and financial markets.
Ortec Finance notes this makes it especially valuable for strategic asset allocation and risk management in multi-asset portfolios, offering a consistent, scalable framework. Its weakness, however, is granularity. Portfolio-level and sector-region assessments frequently fail to capture the diverse economic exposures of individual securities, leaving portfolio managers short of actionable asset-level insight.
Bottom-up analysis works the other way, assessing physical and transition risks at the individual holding level and aggregating up. This yields granular insights that feed directly into portfolio decisions, yet the approach has blind spots of its own. Summing siloed single-asset impacts tends to understate the systemic character of climate risk, and coverage is often limited to listed equities and bonds, leaving private market exposures unassessed.
Many asset owners have responded by adopting both. But Ortec Finance cautions that top-down and bottom-up models are typically built on different methodologies, climate narratives and assumptions, meaning teams within the same organisation can end up relying on conflicting frameworks to address identical risks. A strategic allocation team might use Ortec Finance Climate Scenarios while portfolio construction teams lean on NGFS-based bottom-up models, producing outputs that are difficult to reconcile and undermining consistency from allocation through to security selection.
The solution, the firm argues, is alignment at the sector and regional level, which provides a logical bridge between top-down scenario assumptions and bottom-up company exposures. A combined, consistently aligned approach enables coordinated risk assessment and better informed investment decisions across teams.
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