Carbon investing: does a lower carbon intensity portfolio sacrifice return

In most regions, the low carbon intensity strategy performed in-line with or slightly better than the benchmark, showing that investors could have reduced the carbon intensity of their portfolios without sacrificing returns. In Europe, the low carbon intensity strategy would actually have strongly outperformed the benchmark, with an Information Ratio of 1.20.

There are a few possible explanations for this lack of underperformance. Firstly, it may be that the proportion of investors who are interested in 'green' investing is growing and so green stocks are in heavy demand as these new investors move their assets away from carbon-heavy firms.

Secondly, it may be that governments are introducing new, more aggressive policies to reduce carbon emissions e.g. banning the sale of petrol cars or raising carbon taxes. If so, you would expect that low carbon strategies would work better in the 'dirtiest' sectors which would be most affected by these policies. We did not see this. In fact, the low carbon strategy would have been most effective in the financials sector, which is one of the least carbon intensive.

Thirdly, it may be that low carbon intensity firms are more efficient than their peers and thus higher quality. This is intuitive. If carbon emissions are a good proxy for the use of resources more generally, then low carbon intensity firms are producing goods with fewer resources than their peers.

We did find a strong connection between carbon intensity and quality. The ROE factor portfolio had the lowest carbon intensity of any of the classic quant portfolios. Also, when we regressed the returns to the low carbon intensity strategy onto the returns to a strategy based on a classic measure of firm efficiency, such as asset turnover, we found a positive and statistically significant beta, though there was still a significant alpha, suggesting that low carbon intensity is more than just an efficiency metric.

It appears that investors can drastically reduce the carbon intensity of their portfolios without underperforming and may achieve outperformance. The main threat to the low carbon intensity strategy is that the pool of investors interested in green investing stops growing.