As UN Sounds New Warning on Climate Change, Research Shows High Returns Are Possible With Low Carbon

Cutting carbon exposure had little impact on performance up to reductions of 80 percent, according to a new white paper from PanAgora.

Piotr Malecki/Bloomberg

Piotr Malecki/Bloomberg

In adopting environmentally-friendly portfolio strategies, investors often worry about the repercussions for returns. But Mike Chen, PanAgora Asset Management’s head of sustainable investments, argues investors can have the best of both worlds: low carbon emissions and high returns.

For a new white paper, Chen created a simulated carbon reduction portfolio aimed at minimizing risk and limiting carbon emissions. He then compared the simulation to a benchmark, which was, in this case, the MSCI World Index.

Although simulated performance results have several limitations, he found that cutting carbon exposure had little impact on performance up to the 80 percent carbon reduction level, while an “optimization solution,” a portfolio that yielded the highest possible returns, was possible with up to a 90 percent carbon reduction.

“This confirms what we’re seeing across the portfolio, which is that you don’t have to give up returns to be thoughtful and proactive about climate investing and about investing in carbon reduction strategies,” Meredith Heimburger, director of impact at Global Endowment Management, told Institutional Investor. “A lot of our investments over the last several years have incorporated ESG factors in order to drive excess return and certainly haven’t suffered as a result of investing in more renewable and sustainable strategies.”

The call for investors to take a more climate-focused approach may intensify following the latest warning from the United Nations on climate change. According to an Intergovernmental Panel on Climate Change report released Monday, the Earth’s average temperature, under current conditions, will increase by 1.5 degrees celsius in the coming decades. The UN panel’s report cited human activity as the likely main driver for the extreme environmental changes.


“Sustainable and renewable strategies are no longer nice to have,” said Heimburger. “They are really important to our portfolio constructions. This is going to be part of the future of all portfolios.”

In the PanAgora white paper, Chen noted that it is nearly impossible for investors to achieve 100 percent carbon reduction and maintain benchmark-level returns without outside tools, such as carbon offset contracts. Using a combination of stock selection and carbon offsets, he found that investors can maintain performance and lower carbon emissions.

Net Zero, Not Divestment

Investors also don’t need to divest completely from notoriously carbon-heavy sectors — like utilities, materials, and energy — to minimize their carbon footprints, according to the paper. Instead, Chen suggested that investors can avoid heavy emitters by looking at the carbon emissions of individual companies in a portfolio. Likewise, Heimburger said GEM began offering select institutional clients the option to divest from fossil fuels in 2018, an effort that allowed clients to look at net zero emissions, not just divestment.

“People really cut to extreme ideation when they think about decarbonizing a portfolio,” Sloane Ortel, founder of Invest Vegan and host of the Free Money podcast, told II. “But within the material sector, within the energy sector, there are companies in my portfolio that are leaders and that are some of the most sustainable companies in the world.”

In his report, Chen concluded that it’s a sensible interim goal for investors to use an active-ESG-as-alpha approach to achieve interim sustainability goals, such as a 50 percent carbon reduction.

But for Ortel, deeper changes need to be made in institutional investing for decarbonization and other ESG initiatives to happen on an industry-wide scale. First, the industry needs to undergo a cultural change. For instance, Ortel said there’s significant career risk in posing unconventional ideas at a traditional institution, like a public pension plan.

“Institutional investors need a pathway to make industry leaders feel comfortable about doing something that is a little unconventional,” Ortel said.

Ortel also challenged the indexes investors use to measure performance. In his report, Chen used the MSCI World Index, a commonly-used benchmark. But, Ortel said benchmarks like MSCI and the S&P 500 often limit the opportunities available to investors.

“In general, I think that it’s a failure of imagination to allow the existing way that we describe the opportunity set available to investors [to continue],” she said. “The S&P 500 is this hegemonic narrative. That’s what we talk about when we’re talking about investing. And I think we need to radically update.”