Since his inauguration in January, President Trump has issued a series of executive orders and statements regarding US climate policy, including withdrawing from the Paris Agreement, reducing renewable energy incentives and promoting fossil fuel development.
More widely, overall global emissions are still rising, although emissions in the West are on a clear downward trend. This regional progress reflects a broader shift toward a lower-carbon economy, driven not only by environmental concerns but increasingly by economic and efficiency incentives. However, we recognise that this transition is not linear. Political headwinds and policy uncertainty can create setbacks, making the path forward uneven.
Read also: Race against the benchmark to decarbonise portfolios
Assessing scenarios for company emissions
To take into account the rollback of US climate policies, we are evaluating the potential consequences of US companies reverting to a business as usual approach rather than accelerating their decarbonisation efforts. While we have not yet observed any revisions to decarbonisation targets by US companies in response to recent policy reversals, we analyse the potential impact on their Implied Temperature Rise (ITR) scores, assuming that companies will act more in line with their historical behaviour rather than their stated future commitments.
To better understand the potential impact of such a behavioural shift, we evaluate three scenarios as illustrated in Figure 1:
- Ambitions become reality: Companies fully deliver on their disclosed decarbonisation targets
- Business as usual: Companies revert to historical emission trajectories, disregarding future targets
- Baseline: A middle-ground scenario that reflects current expectations. It combines historical emissions with future targets.
The baseline scenario represents the most realistic view of current corporate climate alignment. Rather than taking companies’ targets at face value, we evaluate the credibility of those targets and adjust their influence accordingly. This results in a credibility-weighted blend of past and projected emissions, which is then used to calculate each company’s ITR.
FIG 1. Three emissions scenarios1
To simulate a shift toward the business as usual scenario, we reduce the weight assigned to the credibility of future targets – up to a full reduction – effectively entirely reverting to historical emissions trends. In other words, we will rely on past carbon emission trends more than we currently do. This way, we can assess how a company-specific return to business as usual would affect its temperature alignment.
Baseline scenario: understanding today's dynamics
Considering both the historical emission trends of companies and their decarbonisation ambitions – weighted by the current credibility of these targets – the baseline ITR for the US companies in the MSCI World index stands at 2.7°C. For comparison, the overall ITR of the MSCI World is slightly lower at 2.5°C.
At first glance, this relatively high temperature for the US may seem surprising, given that it represents the largest allocation within the MSCI World at over 70%. However, it's important to consider the broader regional context, as illustrated in Figure 2.
European companies, for instance, tend to have lower ITRs due to stronger historical decarbonisation and more ambitious targets – often with similar levels of credibility to their US counterparts. At the same time, European firms typically have higher average carbon emissions than their US counterparts, largely because Europe’s economy is more manufacturing-intensive whereas the US economy is more service-oriented.
As a result, Europe exerts a stronger influence on the overall MSCI World ITR than that implied by its index share. When regional ITRs are aggregated, the higher emissions from lower-ITR regions like Europe help pull down the global ITR.
How portfolio ITR is calculated: size matters
A common misconception is to think of portfolio ITR as a simple average of the ITRs of the companies it holds, weighted by their share in the portfolio. However, this is not the case as high-emitting companies have a much bigger impact on the portfolio, regardless of their weighting.
For example, when calculating the average fuel efficiency of a fleet of vehicles, you would not simply average the fuel efficiency of each vehicle based on how many there are. Instead, you would look at how much fuel each uses individually. A heavy-duty truck that burns a lot of fuel will affect the fleet’s average far more than a small, fuel-efficient car, even if there are more of the latter. Similarly, within a portfolio, a high-emitting company can have a much bigger impact on the overall ITR than its portfolio weight might suggest.
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FIG 2. Carbon Investment Ratio (CIR) and ITR by region2
Bad news for climate action, with diverse impacts on sectors
Companies tend to have targets that are more ambitious than their past decarbonisation efforts. Therefore, the ITRs under our ambitions become reality scenario tend to be lower than in the baseline and business as usual scenarios. In a scenario where companies revert entirely to business as usual, the ITR for the US would rise from 2.7°C to 3.4°C, as shown in Figure 3.
FIG 3. ITR of the US carveout of MSCI World3
The difference in ITRs of these two scenarios varies significantly across sectors, as illustrated in Figure 4. For instance, the past emission trends for Energy and Utilities are close to their decarbonisation ambitions, while the Materials and Consumer sectors anticipate a strong acceleration of their decarbonisation efforts. In case of a return to the business as usual scenario, those sectors exhibiting a larger gap will be more impacted.
FIG 4. How different scenarios add to ITR compared to the most ambitious scenario by sector4
Read also: Capturing market upside while benefitting from net-zero tilts
How will TargetNetZero strategies adapt to US climate rollbacks?
Our TargetNetZero strategies favour transitioning companies that are expected to decarbonise faster than their sector peers due to their Paris-aligned ambition levels and credible decarbonisation strategies. We aim to align our portfolio to a below 2°C scenario while maintaining broad diversification across sectors, countries and investment styles to create a core building block for investors. As a result, the strategies typically maintain a tracking error in the range of 0.5% to 1%.
In the case of a return to the business as usual scenario in the US, we will aim to keep the investment process of our TargetNetZero global equity strategy unchanged. Therefore, for this analysis, we will target portfolios’ ITR below 2°C – despite this return to business as usual scenario in the US – while leaving our optimisation objectives and constraints unchanged.
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Evaluating the impact
The impact of US climate rollbacks on the benchmark is meaningful, raising its ITR from 2.5°C to 2.7°C, as shown in Figure 5.
However, this is only one end of the spectrum. In reality, companies may not fully abandon their climate commitments. To reflect this, we also consider intermediate credibility shifts, which allow us to explore a range of outcomes between full target achievement and complete rollback. These scenarios help us better understand the sensitivity of the benchmark and our strategy to varying levels of target credibility.
Even under the most extreme assumption – where US companies revert entirely to historical emission trends – we are still able to construct a portfolio that is aligned with a 2°C pathway.
FIG 5. Portfolio and benchmark ITR in case of a return to a business as usual scenario in the US5
Keeping ITR below 2°C while preserving diversification
As the US shifts back toward a business as usual scenario, fewer companies will transition to a low-carbon economy. Therefore, we must increasingly rely on European and Asian companies to align the portfolio with a below 2°C scenario. To maintain diversification and manage macro risk, we will keep our current regional allocation constraints unchanged to ensure alignment with the benchmark. This means rather than shifting allocations between regions, we will instead emphasise stock selection within regions – favouring transitioners and reducing exposure to laggards within Europe and Asia. As a result, the tracking error contribution from these regions will increase, as illustrated in Figure 6.
FIG 6. Tracking-error contribution by region in case of a return to a business as usual scenario in the US6
While the regional breakdown of the tracking error may experience slight variations, the overall level will remain well below 1%. Additionally, we are able to maintain all of the optimisation constraints, ensuring that our country, sector and stock active weights are managed with the same rigour as today.
A resilient strategy
To gain insight into the effects of US climate rollbacks on our TargetNetZero Global Equity strategy, we undertook a quantitative analysis that allowed for a shift in the US, while all else remained equal. Although we recognise that such a shift could have broader global repercussions, these effects would likely be less pronounced than those observed in the US.
This analysis highlights the resilience of our strategy when tested against a US climate policy rollback being enacted. By incorporating a range of credibility scenarios and maintaining disciplined portfolio construction, we can continue to align with a below 2°C pathway without compromising diversification or risk controls.
To learn more about our TNZ equity strategy, click here.
