Because of the 2015 Paris Agreement, the development of ESG investing and the

emergence of net zero emission policies, climate risk is certainly the most important

topic and challenge for asset owners and managers now and will remain so over the next

five years. It considerably changes portfolio allocation and the investment framework

of both passive and active investors. The goal of this paper is to conduct a survey of the

various climate risk measures that are available in the asset management industry and

the practices of portfolio construction that use these metrics. Therefore, the first part

of this paper lists the different climate risk metrics — e.g., carbon footprint, carbon

transition pathway, carbon transition and physical risks. The second part is dedicated

to portfolio optimization, in particular portfolio decarbonization and portfolio align-

ment (Paris-based benchmarks and net zero carbon objective). Among the different

findings, two are of great importance for investors. First, portfolio decarbonization is

more difficult when we include scope 3 carbon emissions. Indeed, optimizing using the

sum of scopes 1, 2 and 3 emissions leads to a portfolio with more tracking error risk

than using direct plus first tier indirect carbon emissions. Second, portfolio alignment

is more complex than portfolio decarbonization. Since aligning portfolios with scope

3 is becoming the standard approach to climate portfolio construction, the impact on

portfolio management may be substantial, and the divergence between carbon investing

and traditional investing will increase.

Keywords: Climate change, risk measure, carbon emissions, reduction scenario, carbon tra-

jectory, net zero emission, optimized portfolio, decarbonization, portfolio alignment, index

portfolio.

JEL classification: C61, G11, Q54.