building Benchmarks Portfolios with Decreasing Carbon Footprints

There is a growing willingness from asset managers to improve the carbon footprint of their portfolio, to comply with a limit of global warming to 1.5◦C or 2◦C above pre-industrial levels.

In their latest research entitled – Building benchmarks portfolios with decreasing carbon footprints – Eric Jondeau, Benoît Mojon, and Luiz Awazu Pereira da Silva have outlined an accessible methodology to build portfolios with decreasing carbon footprint, which passive investors can use as new Paris-consistent (PC) benchmarks and have the same risk- adjusted returns as business as usual (BAU) benchmarks.

“As the distribution of firms’ carbon intensity is very skewed, excluding a small fraction of highly polluting firms can massively reduce the carbon footprint of a portfolio of corporate stocks. We identify the worst polluters globally, exclude them from the portfolio, and re- allocate the proceeds so as to keep sectoral and regional exposures similar to those of the business as usual (BAU) benchmark.”

Building benchmarks portfolios with decreasing carbon footprints – Eric Jondeau, Benoît Mojon, and Luiz Awazu Pereira da Silva

This approach limits divestment from corporates in Emerging Countries that would result from implementing exclusions and reinvestment without the objective of preserving regional exposures.

The researchers show that reducing the carbon footprint of the portfolio by 64% in 10 years would be obtained by excluding sequentially up to 11% of the corporates, which together amount to less than 6% of the global market portfolio.

While this reallocation preserves regional and sectoral exposures similar to those of the BAU benchmark, it does not change its risk-adjusted return. We define PC benchmark portfolios at the global level, for Emerging Countries, Europe, North America, and the Pacific.

“Our approach is simple and easily implementable.

We first identify the threshold of carbon intensity above which firms should be excluded. Then the proceeds of the excluded firms are reinvested in the same sector and region so as to preserve the regional and sectoral mix of the portfolio.

We show that an emission reduction target of 10% per annum implemented over 10 years between 2010 and 2019 would have reduced the carbon emissions by 64% with respect to the 2009 BAU benchmark. This target would be reached without divestment from Emerging Countries and without any material impact on the risk-adjusted performance of the decarbonized PC portfolio.

We leave the assessment of the success of decarbonizing portfolio on the cost of finance for brown firms and the potential acceleration of effective decarbonizing by corporations to future, complementary research.”

Building benchmarks portfolios with decreasing carbon footprints – Eric Jondeau, Benoît Mojon, and Luiz Awazu Pereira da Silva

Building Benchmarks Portfolios with Decreasing Carbon Footprints is available here.

Source: Building benchmarks portfolios with decreasing carbon footprints – Eric Jondeau, Benoît Mojon, and Luiz Awazu Pereira da Silva