Do investors care about carbon risk? The impact of the Paris agreement on the inflation hedging performance of commodities

It is growingly recognized that a transition to sustainable finance is of utmost importance to scale up the low-carbon investments required to reach the global climate goals. However, financial capital is still widely allocated into economic activities whose profits rely significantly on fossil fuels' extraction, combustion and use, and that do not align to the Paris agreement (PA) targets. This study tests whether the PA has redefined the role of commodities in the portfolio allocation of asset managers, and has unleashed the potential to use this class of assets as an inflation hedge. It assesses whether financial markets are pricing the PA by decreasing the portfolio weights of carbon-intensive commodities afterwards. A dynamic portfolio analysis has been conducted to assess the impact of the PA on the inflation hedging abilities of energy commodities, industrial metals and precious metals. We find evidence that the weight of the copper- one metal that is expected to be a cornerstone of a low-carbon future- within an optimal portfolio tends to increase after the PA. With focus on efforts to achieve a low carbon economy continuing to grow, investors started to consider copper and other industrial metals including cobalt, nickel and aluminum as appealing investment opportunities, but they remain cautious on divesting from the carbon-intensive assets. Overall, our findings suggest that investors are responding to opportunities but less to risks in a low carbon pathway.