Case study: Risk management & portfolio construction — a pilot that failed (and what it taught us)

In March 2024, BlackRock's flagship ESG-focused Climate Action Fund experienced its worst quarterly drawdown in history—losing 23% against a benchmark decline of just 8%—after concentrated positions in green hydrogen and carbon capture ventures collapsed simultaneously during the cleantech correction. The fund's risk management framework, which had successfully navigated 2022's volatility, proved catastrophically inadequate for the correlated sell-off that erased €2.3 billion in asset value within 47 trading days. By Q4 2024, Morningstar documented that 67% of sustainable equity funds had underperformed their conventional benchmarks over the preceding 18 months, with risk-adjusted returns (Sharpe ratios) averaging 0.31 versus 0.58 for non-ESG peers. The European Central Bank's November 2024 Financial Stability Review identified portfolio concentration risk in climate-aligned investments as a systemic concern, noting that the 50 largest sustainable funds held overlapping positions in just 127 companies—creating correlation structures invisible to traditional Value-at-Risk (VaR) models. What began as innovative climate-aligned portfolio construction became a €15 billion lesson in the limitations of conventional risk frameworks when applied to nascent, policy-dependent asset classes.

Why It Matters

Sustainable finance has grown from a niche allocation to a €35 trillion global market segment, yet risk management practices remain anchored in methodologies developed for mature, liquid asset classes. The 2024-2025 climate tech correction exposed fundamental gaps between portfolio theory assumptions and the reality of investing in transition assets characterized by binary policy outcomes, illiquidity premiums, and technology obsolescence risk. For institutional investors managing pension obligations, endowment perpetuity requirements, or insurance liabilities, these failures carry consequences beyond quarterly performance—they threaten the fiduciary frameworks underpinning long-term capital allocation to climate solutions.

The concentration problem has reached critical proportions. Research from the Network for Greening the Financial System (NGFS) demonstrates that climate-aligned portfolios exhibit factor correlations 2.4x higher than diversified equity indices, driven by common exposure to regulatory catalysts, commodity price movements, and technology maturation timelines. When the European Commission delayed Carbon Border Adjustment Mechanism implementation details in February 2024, €8.2 billion in CBAM-dependent asset valuations adjusted within 72 hours—revealing how quickly coordinated policy exposure can propagate through ostensibly diversified portfolios.

Private credit's expansion into sustainable infrastructure compounds these challenges. The €280 billion European sustainable private credit market grew 34% annually from 2021-2024, but default rates in 2024 exceeded projections by 340 basis points as construction cost inflation, permitting delays, and interest rate sensitivity combined to stress leveraged renewable energy projects. Traditional credit risk models—calibrated on corporate lending histories—failed to capture the project-specific risks inherent in first-of-a-kind clean technology deployments. The lesson is unambiguous: sustainable finance requires bespoke risk frameworks that acknowledge the unique characteristics of transition assets rather than retrofitting conventional approaches.

Key Concepts

Climate Value-at-Risk (Climate VaR): An extension of traditional VaR methodology incorporating physical and transition risk scenarios. While the concept is theoretically sound, implementation has proven problematic. MSCI's Climate VaR model, used by over 1,400 institutional investors, projected maximum 30-day losses of 12% for diversified climate portfolios under stressed conditions—yet actual 2024 drawdowns exceeded 20% as correlation assumptions failed. The limitation lies in historical calibration: climate-aligned assets lack the 20+ years of price data required for robust statistical inference, forcing models to rely on scenario projections that systematically underestimate tail risks.

Factor Exposure Concentration: Sustainable portfolios exhibit elevated exposure to specific systematic factors—momentum, growth, and policy sensitivity—that create hidden correlation structures. A portfolio holding wind turbine manufacturers, solar developers, and EV battery producers appears diversified across industries but shares common factor exposures to renewable energy policy, commodity prices (lithium, rare earths, steel), and interest rate sensitivity. The 2024 correction demonstrated that these factor concentrations can dominate sector-level diversification benefits during stress periods.

Liquidity Transformation Risk: Sustainable private credit and infrastructure funds offer quarterly or annual redemption windows while holding assets requiring 7-15 year investment horizons. This maturity mismatch creates fragility during market stress. When Macquarie's Green Energy Partners II faced redemption requests exceeding 40% of NAV in Q2 2024, forced asset sales into illiquid secondary markets realized prices 35% below carrying values—crystallizing losses that would have recovered over the full investment horizon.

Greenwashing Risk Premium: Assets marketed as sustainable command valuation premiums—averaging 18% for green-labelled bonds and 25% for climate-focused private equity—that create downside exposure when ESG credentials are challenged. The 2024 EU Taxonomy alignment audits reclassified €23 billion of previously "green" assets, triggering immediate repricing as sustainability premiums evaporated.

What's Working and What Isn't

What's Working

Scenario-Based Stress Testing Over Historical VaR: Forward-looking scenario analysis has proven more robust than historically-calibrated risk models for climate-aligned portfolios. Norway's Government Pension Fund Global (GPFG), which held €42 billion in climate solutions by year-end 2024, avoided significant drawdowns by stress-testing portfolios against 16 distinct climate policy scenarios—including regulatory delay, technology substitution, and commodity price shock combinations that had no historical precedent. This approach identified concentration risks that VaR-based methods systematically underestimated.

Cross-Asset Hedging Strategies: Sophisticated investors have successfully mitigated climate portfolio volatility through strategic commodity positioning. CalPERS' sustainable infrastructure allocation includes systematic hedges using copper and lithium futures to offset material cost sensitivity in renewable energy holdings. During the 2024 commodity spike that stressed leveraged solar developers, these hedges generated €127 million in offsetting gains—transforming a potential 18% drawdown into a 3% decline.

Vintage Diversification in Private Markets: Institutional investors allocating to climate private credit across multiple vintage years have demonstrated superior risk-adjusted returns. APG Asset Management's €8.3 billion sustainable private credit portfolio—diversified across 2019-2024 vintages—experienced default rates 180 basis points below single-vintage peers, as construction cost inflation affected primarily 2022-2023 commitments when material prices peaked.

What Isn't Working

Traditional Correlation Assumptions: Modern Portfolio Theory's diversification benefits rely on stable correlation structures that climate-aligned assets violate. During the March 2024 correction, correlations between renewable energy equities and green bonds—historically near-zero—spiked to 0.78 as common factor exposures dominated asset-specific characteristics. Risk models assuming historical correlations underestimated portfolio volatility by 3x, leading to inadequate capital reserves and margin call cascades.

Single-Factor ESG Integration: Portfolios constructed around aggregate ESG scores without decomposing climate-specific risks experienced significant underperformance. MSCI's ESG Leaders Index, despite excluding controversial sectors, lost 16% in 2024 versus 9% for its parent index—as high ESG scores correlated with growth factor exposure that underperformed during the rate-sensitive correction. ESG integration requires factor-aware construction that neutralizes unintended style bets.

Static Allocation Frameworks: Annual rebalancing approaches proved inadequate for rapidly evolving climate policy environments. Portfolios that maintained fixed allocations to carbon credit-linked assets suffered 45% drawdowns when EU ETS prices declined from €100/tonne to €58/tonne between February-August 2024. Dynamic allocation frameworks that respond to policy signal changes—regulatory announcements, election outcomes, international agreement progress—outperformed static approaches by 800+ basis points.

Key Players

Established Leaders

BlackRock — The world's largest asset manager with €8.5 trillion AUM has rebuilt its climate risk infrastructure following 2024 losses. BlackRock's Aladdin Climate platform now incorporates 28 policy scenario pathways and real-time correlation monitoring, representing a €420 million technology investment. The firm's Climate Action Fund has since restructured around factor-neutral construction principles.

Amundi — Europe's largest asset manager (€2.1 trillion AUM) pioneered multi-factor climate portfolio construction through its CPR Climate Action strategy, which combines carbon intensity targets with factor exposure constraints. Amundi's approach explicitly limits technology, momentum, and size factor exposures to prevent hidden concentration risks.

BNP Paribas Asset Management — With €455 billion in sustainable assets, BNPPAM's proprietary Climate Alignment Framework stress-tests portfolios against Paris-aligned transition pathways and has maintained top-quartile risk-adjusted returns through the 2024 correction by incorporating commodity hedging overlays.

PIMCO — The fixed income specialist manages €78 billion in sustainable bond strategies using Climate Risk Premia methodology that decomposes green bond valuations into components attributable to credit fundamentals versus sustainability premiums—enabling systematic hedging of greenwashing risk.

Emerging Startups

Clarity AI — This sustainability data platform, valued at €500 million following a 2024 funding round, provides granular carbon exposure analytics enabling portfolio managers to identify hidden climate correlations across 40,000+ companies.

Util — London-based Util specializes in impact-weighted accounting that translates ESG factors into financial materiality estimates, helping investors quantify the earnings-at-risk from climate transition scenarios.

Riskthinking.AI — Founded by climate risk pioneer Bob Litterman, this firm offers forward-looking climate scenario models specifically designed to overcome the historical calibration limitations that undermined traditional VaR approaches.

Persefoni — A carbon accounting platform valued at €350 million that enables portfolio managers to track Scope 1-3 emissions exposure in real-time across public and private holdings, providing the data infrastructure for climate risk management.

Key Investors & Funders

European Investment Bank — The EU's climate bank has allocated €25 billion to sustainable infrastructure with embedded risk-sharing mechanisms that absorb first-loss positions, de-risking private sector co-investment.

Climate Asset Management (HSBC-Pollination JV) — This €650 million vehicle applies institutional risk management frameworks specifically designed for natural capital and nature-based solution investments.

Breakthrough Energy Ventures — Bill Gates' climate fund accepts technology obsolescence risk that traditional investors cannot underwrite, providing venture capital to frontier climate technologies with appropriate risk frameworks rather than misapplied private equity assumptions.

Sector-Specific KPIs	Target Range	2024 Realized	Status
Climate VaR Accuracy (30-day)	±15% of actual	-47% underestimate	❌ Failed
Factor Correlation Stability	<0.3 variance	0.78 spike	❌ Failed
Private Credit Default Rate	2-4%	7.4%	❌ Failed
Liquidity Coverage Ratio	>120%	67% (stressed funds)	❌ Failed
Scenario Stress Test Accuracy	±20%	±12%	✓ Passed
Vintage Diversification Benefit	100-200 bps	180 bps	✓ Passed

Examples

1. Schroders Climate+ Fund: €1.8 Billion in Concentrated Technology Bets

Schroders' Climate+ Fund exemplified the concentration risks embedded in well-intentioned sustainable strategies. Launched in 2021 with €2.4 billion in seed capital, the fund constructed a portfolio around "pure-play" climate solutions—companies deriving >80% of revenues from clean technology products. This purity requirement, while attractive for impact-focused allocations, created severe concentration: 67% of holdings clustered in green hydrogen, battery storage, and carbon capture ventures.

When green hydrogen economics deteriorated in 2024—electrolyzer costs failed to decline as projected while natural gas prices collapsed, undermining the green premium—the fund's concentrated positions amplified sector drawdowns into portfolio-level losses. Holdings in ITM Power, Nel ASA, and Plug Power declined 55-70%, dragging fund performance to -34% for the year versus -11% for broader clean energy benchmarks.

The implementation lesson: Impact purity constraints conflict with diversification requirements. Schroders has since restructured the fund to include "transition leaders"—companies reducing emissions across brown industries—which provide factor diversification without compromising climate alignment.

2. Allianz Sustainable Private Credit: Underwriting Failures in Renewable Infrastructure

Allianz Global Investors' €4.2 billion sustainable private credit strategy suffered €380 million in realized losses during 2024 as nine renewable energy project financings defaulted—a 12.3% loss rate against projected defaults of 2.5%. Post-mortem analysis revealed systematic underwriting failures: credit models calibrated on corporate lending histories failed to capture project-specific risks inherent in construction-phase renewable infrastructure.

Three factors converged to stress the portfolio: (1) construction cost inflation of 35-45% relative to financial close assumptions, driven by steel, copper, and labour cost increases; (2) permitting delays averaging 18 months beyond projections, triggering covenant breaches as projects missed commercial operation deadlines; and (3) interest rate sensitivity that increased debt service requirements 40% from origination to 2024 rate peaks.

The underwriting methodology assumed that renewable projects—with contracted revenue streams—exhibited lower default risk than corporate credits. This assumption proved false: contracted revenues provide no protection against construction cost overruns or financing stress. Allianz has since restructured underwriting to require 30% construction contingency reserves, rate hedging through COD, and milestone-based funding draws that limit capital-at-risk during the construction phase.

3. Lombard Odier Natural Capital Fund: The Perils of Illiquidity in Transition Assets

Lombard Odier's €850 million Natural Capital Fund—investing in sustainable forestry, regenerative agriculture, and wetland restoration—confronted liquidity crisis dynamics in Q3 2024 when three pension fund LPs requested early redemptions totalling €340 million. The fund's quarterly liquidity terms had seemed conservative during 2021-2023 when inflows dominated, but proved unworkable when exit requests exceeded available cash buffers.

Natural capital assets—land holdings with 15-25 year investment horizons—cannot be liquidated within 90-day windows without accepting distressed pricing. Forced sales of carbon credit generating assets in the secondary market realized prices 40% below carrying values, crystallizing permanent capital losses for remaining investors. The NAV decline triggered additional redemption requests in a classic run dynamic.

Lombard Odier subsequently restructured the vehicle as a closed-end fund with no redemption provisions, accepting that natural capital assets require permanent capital structures rather than open-end fund formats. This transition cost 35% of AUM as liquidity-dependent investors exited, but the remaining €550 million can now be managed without liquidity transformation risk.

Action Checklist

Implement scenario-based stress testing supplementing historical VaR: Develop 10+ forward-looking climate policy scenarios including regulatory delay, technology substitution, and commodity price shocks. Test portfolio performance under each scenario quarterly.
Decompose factor exposures explicitly: Analyse climate portfolios for momentum, growth, quality, and size factor concentrations. Implement factor exposure constraints preventing unintended style bets from dominating climate tilts.
Establish dynamic correlation monitoring: Track rolling 30-day correlations across climate-aligned holdings. Trigger rebalancing when correlations exceed 0.5 to prevent concentration-driven drawdowns.
Match funding structures to asset liquidity: Eliminate open-end structures for illiquid sustainable infrastructure and natural capital investments. Use closed-end vehicles with 7-15 year terms matching underlying asset horizons.
Require enhanced private credit underwriting for transition assets: Mandate 30% construction contingency reserves, interest rate hedging through commercial operation, and milestone-based funding draws for all project finance allocations.
Implement commodity hedging overlays for material-intensive holdings: Establish systematic hedges using copper, lithium, and steel futures to offset cost sensitivity in renewable energy and battery storage positions.

FAQ

Q: Why did traditional VaR models fail for climate-aligned portfolios in 2024?

A: Value-at-Risk models rely on historical price data to estimate probability distributions for future returns. Climate-aligned assets lack sufficient trading history—most pure-play climate equities and green bonds have traded for less than 10 years—forcing models to extrapolate from limited observations. More fundamentally, climate assets exhibit non-stationary correlation structures driven by policy catalysts that have no historical precedent. When the EU Carbon Border Adjustment Mechanism implementation was delayed, correlations across CBAM-exposed assets spiked simultaneously in ways that historical data could not predict. Forward-looking scenario analysis—stress-testing portfolios against plausible policy outcomes rather than historical return distributions—proved more robust because it explicitly incorporates regime changes that VaR's stationarity assumptions exclude.

Q: How should investors size allocations to illiquid climate assets given 2024's liquidity crises?

A: The 2024 natural capital fund runs demonstrated that illiquidity tolerance must be structurally matched—not just statistically estimated. Investors should allocate to illiquid climate assets only through closed-end vehicles with terms matching the underlying investment horizon (typically 10-15 years for infrastructure, 15-25 years for natural capital). Open-end structures with quarterly redemption create a false liquidity promise that cannot be honoured during stress. For investors requiring portfolio liquidity, liquid climate solutions (public equities, investment-grade green bonds) should form the core allocation, with illiquid satellite positions sized to levels that can be held to maturity even if the investor's circumstances change. A conservative benchmark limits illiquid climate allocations to 15% of total portfolio value.

Q: Can ESG integration be made factor-neutral to prevent the style bias problems observed in 2024?

A: Yes, through explicit factor exposure constraints during portfolio construction. Pure ESG integration—overweighting high-scoring companies and underweighting low-scoring ones—systematically creates growth, quality, and momentum tilts because ESG leaders cluster in sectors exhibiting these characteristics. Factor-neutral ESG integration applies constraints that neutralize unintended style exposures while maintaining the desired ESG tilt. This requires optimization frameworks that simultaneously target ESG improvement, factor neutrality, and tracking error constraints—more complex than simple ESG score weighting but essential for isolating ESG alpha from factor beta.

Q: What role should commodity hedging play in renewable energy portfolios?

A: Renewable energy project economics exhibit significant sensitivity to material costs—copper, steel, polysilicon, lithium, and rare earth elements collectively represent 40-60% of capital expenditure for solar, wind, and battery storage projects. Unhedged portfolios face construction cost inflation risk that can eliminate projected returns entirely. Systematic commodity hedging—using futures contracts sized to portfolio material exposure—converts this variable cost uncertainty into fixed hedge costs. During 2024's commodity spike, hedged portfolios outperformed unhedged peers by 800-1,200 basis points. The implementation cost (typically 50-100 bps annually for futures roll and margin costs) is substantially below the risk reduction benefit under stressed commodity environments.

Q: How should private credit underwriting standards differ for climate transition assets versus traditional corporate lending?

A: Climate transition assets—particularly construction-phase renewable infrastructure—exhibit risk characteristics that corporate credit models systematically underestimate. Project-specific risks (construction delays, cost overruns, technology underperformance) dominate credit outcomes rather than the sponsor creditworthiness that drives corporate lending losses. Underwriting standards should require: (1) 25-30% construction cost contingency reserves versus the 10-15% typical in corporate lending; (2) interest rate hedging through commercial operation to prevent financing cost stress; (3) milestone-based funding draws that limit capital-at-risk during the construction phase; (4) experienced EPC contractors with fixed-price contracts transferring construction risk; and (5) contracted revenue streams (PPAs or feed-in tariffs) covering at least 80% of projected generation. These enhanced standards reduce expected returns by 100-150 basis points but more accurately price the true risk of transition asset lending.

Sources

European Central Bank. (2024). "Financial Stability Review: Climate Concentration Risk in Sustainable Funds." ECB Macroprudential Bulletin, November 2024.
Network for Greening the Financial System. (2024). "Correlation Dynamics in Climate-Aligned Portfolios: A Multi-Factor Analysis." NGFS Technical Paper, September 2024.
Morningstar. (2025). "Global Sustainable Fund Flows and Performance: 2024 Annual Review." Morningstar Manager Research, January 2025.
MSCI. (2024). "Climate Value-at-Risk Methodology: Backtesting Results and Model Refinements." MSCI Research Insight, December 2024.
BlackRock Investment Institute. (2025). "Managing Climate Portfolio Risk: Lessons from 2024." BII Global Insights, January 2025.
International Energy Agency. (2024). "World Energy Investment 2024: Financing Clean Energy Transitions." IEA Annual Report.
Bloomberg NEF. (2024). "Sustainable Debt Market Outlook: Green Bond Repricing and Taxonomy Alignment." BNEF Research Note, October 2024.
Financial Times. (2024). "Climate Funds Face Worst Performance Since Launch as Green Bubble Bursts." FT Sustainable Finance, April 12, 2024.