Fund portfolio networks: a climate risk perspective

Abstract

Within the European financial sector, investment funds are more exposed to climate-sensitive economic sectors than banks, insurers and pension funds. However, few investment fund climate-related financial risk assessments have been conducted. We attempt to help fill this gap, using a dataset of EUR 8 trillion of European investment fund portfolio holdings. We recover the network of fund portfolio overlaps (interconnections) and augment this with information on the relative environmental performance ('dirtiness') of fund portfolios. Funds whose portfolios are tilted towards more polluting assets (brown funds) distribute their portfolio over a larger number of companies than funds with cleaner portfolios (green funds). This apparent diversification hides a concentration risk: brown funds are more closely connected with each other (have more similar portfolios) than green fund portfolios, which tend to ‘herd’ less (have less similar portfolios to those of other green funds). This suggests that widespread climate-related financial shocks are likely to disproportionately affect brown funds. A climate risk scenario exercise confirms this: within total system-wide losses of EUR 152 billion to EUR 443 billion, most brown funds’ losses range from about 9% to 18% of affected assets, in contrast to green funds’ losses, which usually range from 3% to 8%. In addition, brown funds have more systemic impact: they contribute more to total system-wide losses (by virtue of their greater interconnections within the fund universe) than green funds. These findings provide support for ongoing EU regulatory and supervisory initiatives on sustainable finance.