Quick Take: Must Decarbonization Bite When Emitters Outperform?
The 2022 investing environment: Motivation to overweight emitters
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As commodity prices soared in 2022, there was natural motivation for active strategies that didn’t include explicit carbon constraints or tilts to increase exposure to high emitting sectors, owing to industry and stock selection opportunities associated with the changing market environment.
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To illustrate, the top chart shows a dramatic increase in the Weighted Average Carbon Intensity (WACI) of a hypothetical baseline systematic global strategy that incorporates bottom up and top down return forecasts and sophisticated portfolio construction. For most of the year, its WACI is more than twice that of the benchmark and Net Zero compliant levels.
Can low-carbon clients maintain alpha when conditions favor emitters?
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Yet even in conditions that favor emitters, sophisticated systematic carbon-constrained strategies can still retain substantial alpha exposure. As the bottom chart illustrates, adding a carbon exposure constraint to the simulated baseline global portfolio reduces ex-ante alpha exposure by less than 10% during 2022, and we see the same for regional variants of the hypothetical strategy. Moreover, in less extreme market environments, like in 2021, the drop-off in alpha exposure is negligible.
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This success in maintaining alpha exposure derives from a broad investment universe and sophisticated portfolio construction. That combination provides flexibility to overweight high-alpha, carbon-efficient stocks in high-emitting sectors. As evidence, after adding the carbon constraint to the hypothetical global strategy, the portfolio is still able to take a 4% overweight to energy during 2022.
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The results offer evidence that when the investing climate benefits emitters, sophisticated approaches to decarbonization can help investors better maintain key financial characteristics of their investments.
Weighted Average Carbon Intensity (WACI)
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Impact of Carbon Constraints on Ex ante Alpha Exposure
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