Adoption of ESG investment principles is a global trend for investors. While different regions are in various stages of implementation, we see a consistent theme: the reduction of carbon emissions in portfolios, some with the stated goal of getting to “net zero.” But how do we get there and how long could it take?
Why net zero?
There are several reasons to reduce or remove carbon emissions from your portfolio. Investors may have financial objectives based on their risk/return trade-off, or non-financial objectives like using their portfolio to drive real-world outcomes.
AQR Head of ESG Research Lukasz Pomorski discusses a few reasons to consider carbon reduction (00:55)
The implementation of these carbon commitments are often considered over 10, 15 or 20 years, as many investors may not want to rush to adopt a very aggressive carbon goal.
But why wait?
If you want to enact a real change today, there are several levers you can use to adjust your portfolio. We discuss three solutions to help achieve net zero emissions:
1.) Tilt away from carbon emitters: It’s possible to reduce a portfolio’s carbon footprint meaningfully by shifting away from high carbon emitting companies, which represent a relatively concentrated portion of the benchmark. Unfortunately, this approach alone cannot achieve net zero in long-only portfolios.
Lukasz Pomorski on staying diversified while avoiding companies with high carbon emissions (00:38)
2.) Offset carbon emissions implied in an investment portfolio: Carbon offsets allow investors to fund activities that mitigate carbon emissions, and then use the prevented emissions to “offset” their own emissions. Carbon permits are a related instrument, issued for example by the California Air Resources Board or EU Emissions Trading System (ETS) to give an emitter the right to emit greenhouse gases. This approach is more costly and controversial, but we do believe you can find high quality offsets that truly are additive to carbon removal efforts.
3.) Short carbon emitters: Investors can offset carbon emissions of the stock they buy with the emissions of the stock they short. This approach can actually take a portfolio past net zero and into negative carbon exposure. Through shorting, investors can also indicate their views on the largest emitters. There are costs of shorting to consider, however, and doing so requires the acceptance of using “portfolio carbon offsets.”
Lukasz Pomorski on the impact of shorting (00:20)
Investors looking to meaningfully reduce or even remove their exposure to carbon emissions in their investment portfolios have a few options to consider. While there is no silver bullet, we believe a combination of these three approaches will help investors meet their net zero goals in the near-term.
Lukasz Pomorski explains why there is ‘no silver bullet’ for carbon reduction (00:44)
Source: AQR. As of March 30, 2021. The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of AQR Capital Management, LLC, its affiliates or its employees. This information is not intended to, and does not relate specifically to any investment strategy or product that AQR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of experiencing investment losses.