Close
Albacore-horizontal-black800.png

At AlbaCore, we focus on the long-term. As one of Europe’s leading alternative credit specialists, we invest in private capital solutions, opportunistic and dislocated credit and structured products. 

Discover more
Close
FSSA-logo-colour-png.png

Specialist in Asia Pacific, China, India and South East Asia and Global Emerging Market equities.

Discover more
Close
igneo-logo-rgb-horiz.png

Our philosophy is very simple. We are constantly searching for high quality businesses and when we acquire them, we will work relentlessly with them to create long-term sustainable value through innovation, ESG-led and proactive asset management.

Discover more
Close
rqi-investors-logo-ash-mint.png

Leader in active quantitative equities across Australian equities, global equities, emerging markets and global small companies.

Backed by a unique blend of research, portfolio construction and risk management, focused on uncovering original insights and translating them into investment strategies that are active and systematic, aiming to generate alpha.

Discover more
Close
SI-logo-black-png.png

Specialists in equity portfolios in Asia Pacific, emerging markets, global and sustainable investment strategies

Discover more
  • Latest insights
  • Reduce carbon without sacrificing returns – can investors have it all?

Reduce carbon without sacrificing returns – can investors have it all?

From net zero pathways to climate action to the perils of greenwashing, the business headlines do not always paint a positive picture for investors pursuing strong returns in their portfolios with a sustainability agenda in mind.

Climate change isn’t going away and although it feels like a battle to be fought by governments, businesses and fund managers, the truth is that the drive for climate action is much closer than you think, at least in your investment portfolio. Increasingly, fund managers recognise the transition to net zero as both a risk to control and a potential source of investment opportunities1, while aligning portfolios with a net zero trajectory. For investors, there is potential to drive a powerful trend towards greater climate action by selectively investing in funds.

Top of mind for most investors, however, is whether exposure to the decarbonisation megatrend sacrifices returns. Can we have it all? The answer actually is yes, but it’s also complicated.

A word on tracking error

While rarely considered by average investors, tracking error is an important measure to assess how closely to the benchmark a portfolio will likely perform – broadly speaking, it measures the width of the bell curve of annual portfolio performance relative to the benchmark. Of course, the more a portfolio’s allocations differ from a benchmark, the higher the tracking error is likely to be.

For investors who want to incorporate environmental, social and governance (ESG) characteristics, like reduction in carbon emissions, into their portfolio but with a preference for benchmark-type risk and returns, low tracking error is important.

Intuition suggests that reducing carbon intensity would have a marked effect on tracking error, and perhaps returns. Our analysis tells a surprising story.

Reallocating within rather than out of sectors

Investors wanting to integrate decarbonisation into their overall investment strategy might consider sector exclusions or divestment of companies that generate significant carbon emissions. Selling down positions in companies in the highest carbon intensive sectors can get investors the biggest carbon intensity reductions, but it can also introduce more portfolio risk and tracking error, as well as having a material impact on returns.

However, it is possible to achieve carbon reductions in a portfolio without necessarily selling out of a sector. To do this in a controlled way, we use each stock’s carbon intensity as our central measure (carbon intensity is Scope 1 and 2 greenhouse gas emissions per million dollars of sales.). This scores stocks strictly on their emissions through their operations and is agnostic to the value of a company.

Within individual sectors or industries, it is worth noting that stocks have broad ranges of carbon intensity – many stocks with little or no carbon intensity and a few stocks with a great deal. Indeed, in most sectors of the global stock market, we found that a 30% reduction in carbon intensity could be achieved by excluding less than 10% of the stocks by value – energy was the exception, requiring 11.5% to be excluded.  

Our central analysis – and our main results – show that it is possible to achieve moderate levels of carbon intensity reduction in a portfolio with minimal addition of tracking error. By ‘trading up’ for carbon leaders – those with less carbon intensity – within the same sector or industry instead of shifting sector weights when reallocating portfolios, we also found that there is little effect on portfolio alpha, the return generated above that of the benchmark.

Aussie carbon disadvantage

Different geographies will offer different opportunities for reductions in carbon intensity and tracking error for investors.

Perhaps not surprising is the finding that it is more challenging to decrease carbon intensity with minimal addition of tracking error in Australian equities portfolios. This reflects the concentration of higher carbon intense sectors in the Australian index compared to broader global equities indices.

Compare Australian portfolios to global portfolios that have a larger stock universe. In global, we find surprisingly small tracking error for quite large reductions in carbon intensity. For example, a 40% reduction in carbon intensity in MSCI ACWI ex-AU, an international equity index excluding Australian stocks, would only have generated a historic tracking error of 0.10% p.a in the period of December 2008 to June 2022.

For Australia, with a smaller and more resource-oriented market, the impact is higher. For example, decreasing carbon intensity by 30% for the ASX200 adds about 0.50% p.a. of tracking error. This can hamper an investor’s ability to rotate to stocks with less carbon intensity within a sector because there are less options to do so.

Conclusion

For the carbon conscious investor, aligning to the net zero agenda is possible with minimal risk and reward implications in reallocating portfolios. Our study found that moderate adjustments towards lower carbon stocks in well-diversified portfolios can result in substantial carbon intensity reductions with minimal addition of tracking error.

1 For example, there are 301 signatories representing USD 59 trillion in AUM to the Net Zero Asset Managers initiative. This is an international group of asset managers committed to supporting the goal of net zero greenhouse gas emissions by 2050 or sooner, in line with global efforts to limit warming to 1.5 degrees Celsius, and to supporting investing aligned with net zero emissions by 2050 or sooner.

Important Information

This material is for general information purposes only. It does not constitute investment or financial advice and does not take into account any specific investment objectives, financial situation or needs. This is not an offer to provide asset management services, is not a recommendation or an offer or solicitation to buy, hold or sell any security or to execute any agreement for portfolio management or investment advisory services and this material has not been prepared in connection with any such offer. Before making any investment decision you should consider, with the assistance of a financial advisor, your individual investment needs, objectives and financial situation. We have taken reasonable care to ensure that this material is accurate, current, and complete and fit for its intended purpose and audience as at the date of publication. No assurance is given or liability accepted regarding the accuracy, validity or completeness of this material and we do not undertake to update it in future if circumstances change. To the extent this material contains any expression of opinion or forward-looking statements, such opinions and statements are based on assumptions, matters and sources believed to be true and reliable at the time of publication only. This material reflects the views of the individual writers only. Those views may change, may not prove to be valid and may not reflect the views of everyone at First Sentier Investors. 

About First Sentier Investors

References to ‘we’, ‘us’ or ‘our’ are references to First Sentier Investors, a global asset management business which is ultimately owned by Mitsubishi UFJ Financial Group. Certain of our investment teams operate under the trading names FSSA Investment Managers, Stewart Investors and Realindex Investments, all of which are part of the First Sentier Investors group. We communicate and conduct business through different legal entities in different locations. This material is communicated in:

  • European Economic Area by First Sentier Investors (Ireland) Limited, authorised and regulated in Ireland by the Central Bank of Ireland (CBI reg no. C182306; reg office 70 Sir John Rogerson’s Quay, Dublin 2, Ireland; reg company no. 629188)
  • United Kingdom by First Sentier Investors (UK) Funds Limited, authorised and regulated by the Financial Conduct Authority (reg. no. 2294743; reg office Finsbury Circus House, 15 Finsbury Circus, London EC2M 7EB)
  • other jurisdictions, where this document may lawfully be issued, by First Sentier Investors International IM Limited, authorised and regulated in the UK by the Financial Conduct Authority (FCA ref no. 122512; Registered office: 23 St. Andrew Square, Edinburgh, EH2 1BB; Company no. SC079063).

To the extent permitted by law, MUFG and its subsidiaries are not liable for any loss or damage as a result of reliance on any statement or information contained in this document. Neither MUFG nor any of its subsidiaries guarantee the performance of any investment products referred to in this document or the repayment of capital. Any investments referred to are not deposits or other liabilities of MUFG or its subsidiaries, and are subject to investment risk, including loss of income and capital invested.

© First Sentier Investors Group