Across the globe, more and more investors are finding it in their best interest to integrate climate risk within their investment considerations.

A series of issues arises – How do we define and measure ESG factors? Perhaps the most topical metric today is greenhouse gas emissions. Yet, while we can measure a company's emissions, how do we measure the emissions of its suppliers? And do we measure emissions created by a company's products after they leave its control, when they are used by the consumer? How do we translate this into a portfolio metric?

  • We analyse the relative merits and portfolio characteristics of two common carbon optimisation strategies used by investors, Exclusion and Optimisation. Our carbon intensity and tracking error simulations showed that an Optimisation approach could produce a significant reduction in portfolio CO2 with modest tracking error, and minimal industry skew.
  • We show that portfolios containing stocks with the lowest carbon intensity generally tended to outperform the global universe whilst the reverse was true for the ‘carbon-cutting laggards’ over a nine year period starting at the end of 2009.
  • We provide a concrete example by describing a tailor-made equity solution which has reduced portfolio CO2 by over 50%, while limiting tracking error below 1% relative to a custom benchmark. At the same time, the solution improves the overall ESG risk profile, and addresses other climate issues requested by the pension fund. 

We believe these methodologies will become mainstream in the near future.


This Research Paper is dedicated for professional investors only