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From risk to alpha: Why investors focus on decarbonization investment strategies

Keesa Schreane
Keesa Schreane
Director of Risk and Sustainability Partnerships. Producer and Host of Refinitiv Perspectives LIVE

How does decarbonization play into the investment strategies of financial players today? And how do these strategies differ across Europe and the U.S.? This week on the Refinitiv Sustainability Perspectives Podcast, we speak to Bridgit Realmuto LaPerla – the co-author of Decarbonization Factors, a study from Harvard Business School and State Street Associates – to learn about the factors driving sustainable investment forward.


  1. Climate change is impacting how investors manage their portfolios. Investing in climate change was once viewed as risky. Now it can now drive alpha.
  2. The most aggressive carbon strategies generate the strongest alpha. For institutional investors in Europe especially, this means allocating funds to the lowest carbon firms within the market.
  3. Decarbonization investment strategies in the U.S. and Europe perform very differently, with factors such as climate change legislation and varying political climates having an impact.

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As we’re seeing the negative effects of climate change increase, most people are (rightfully) concerned about its impact across the world. Almost half of Americans feel people in the U.S. are being harmed by climate change right now, which is a 16% uptick from 2015. Additionally, 72% of Americans say global warming is extremely, very or somewhat important to them on a personal level.

Institutional investors are by no means immune to the effects of climate change and many are feeling the pressure to add climate risk to their portfolios. Climate change has therefore also made an impact on how they are managing their investments. Many are now focusing on decarbonization investment strategies and sustainable investing.

“There’s an increased number of investors who see climate change as an economically significant event, not just in the long term but affecting portfolio performance now,” said Bridgit Realmuto LaPerla, who is the Head of ESG Research at State Street Associates.

Realmuto LaPerla is also the co-author of a new study called Decarbonizations Factors, which delves into the performance of portfolio decarbonization strategies in Europe and the U.S. And, we had a great conversation with her about her work on our most recent episode of the Refinitiv Sustainability Perspectives Podcast (which you can take a listen to here).

In this article, we’ll take a closer look at how exactly investors should focus on decarbonization today – and what factors lead to the best returns.

Investor interest

Climate investing was once viewed as risky. But times have certainly changed. With more companies working to combat their carbon emissions, investors have the opportunity to allocate their funds more sustainably – and with real financial results.

Investors need to pay attention to climate change in their strategies,” said Realmulto LaPerla. “It can drive alpha.”

And in recent years, points out Realmulto LaPerla’s study, “new products are being launched to offer options for investors that seek exposure to portfolios with a lower carbon footprint.”

For example, the New York State Common Retirement Fund – which is the third largest public pension plan in the U.S. – doubled its low emissions investment to $4 billion in 2018.

American pension fund California State Teachers’ Retirement System (CalSTRS) committed $2.5 billion to low carbon strategies in 2016, and then implemented a low carbon work plan in October 2019 – just as wildfires spread across the state.

And last April, Norway’s oil fund, which is worth $1 trillion, pledged to invest billions in wind and solar and divest from more than 100 oil and gas companies. 

These are just a few cases. In fact, according to a 2018 report by Arabella Advisors, almost 1000 institutional investors worth $6.24 trillion worldwide are divesting from fossil fuels – an increase of 11,900% from four years ago.

That’s why Refinitiv is focusing on the continuous improvement and development of its ESG database. It covers almost 400 metrics and 70% of global market cap, giving the growing number of investors prioritizing decarbonization access to official company disclosure data on ESG metrics – which helps them to quickly measure sustainable investment decisions.

How investors decarbonize matters

The study looked at six decarbonization strategies between 2009 and 2018 across Europe and the U.S.. These included strategies in which investors honed in on specific firms – and others in which investors focused on entire industries, but allocated funds to the lowest carbon firms and stayed away from high carbon firms.

Overall, the study found a positive relation between decarbonization alpha and portfolio decarbonization and in strategies with a high carbon footprint reduction. But, which strategies performed best?

The study looked at six decarbonization strategies between 2009 and 2018 across Europe and the U.S.. These included strategies in which investors honed in on specific firms – and others in which investors focused on entire industries, but allocated funds to the lowest carbon firms and stayed away from high carbon firms.

Overall, the study found a positive relation between decarbonization alpha and portfolio decarbonization and in strategies with a high carbon footprint reduction. But, which strategies performed best? 

According to Realmuto La Perla, the least restrictive, most aggressive carbon strategies produced the strongest alpha over time.

This was most notable in Europe; those decarbonization strategies that consisted of selecting the best firms within the market to invest in, achieved the greatest decarbonization alpha.

In the U.S., those who selected the best sectors in the market produced the best decarbonization alpha.

The study also found a relationship between decarbonization factor flows and returns. “The decarbonization factors perform consistently well, delivering positive and significant alpha, when contemporaneous flows are positive. Our results suggest that institutional investor flows contain information about the returns of decarbonization strategies,” it concluded.

The difference between the U.S. and Europe

As we mentioned above, the performance of decarbonization strategies differ by region. This is particularly true in Europe (which is regulation-driven) and the U.S. (which has less legislation surrounding carbon emissions).

The European Union boasts the EU Emissions Trading System (EU ETS). As the world’s first and largest carbon market, the EU ETS puts a cap on greenhouse gases. Companies can then buy and trade emissions allowances, which makes it more expensive for those who produce high emissions to do business. In fact, carbon prices in the EU reached an 11-year high in 2019.

In France there’s also Article 173, which since 2015 has asked investors to explain how they incorporate ESG into their investment policies – including climate change investment. It’s the first country in the world to impose such requirements.

Of course, it’s no secret there’s far less legislation regarding climate change in the U.S. as a whole. However, that’s not to say some states haven’t taken action on their own.

A number of states have joined together to set up the Regional Greenhouse Gas Initiative (RGGI), which consists of individuals CO2 budget trading programs. There are nine states involved in total – including; Delaware, Connecticut, Maine, Massachusetts, Maryland, New Hampshire, New York, Vermont and Rhode Island. California also has its own cap-and-trade program.

And through a new bill approved by the House Financial Services Committee in September, the U.S. has also started to develop legislation that would require public companies to divulge their ESG metrics.

Timing

We’ve gone over how the performance of low carbon strategies can vary across regions. And yes, this is oftentimes because of legislation. But low carbon strategies are also affected when important regional events occur  – or when the political climate shifts.

“We found that timing matters around this. This is not static,” said Realmuto LaPerla.

For example, the study shows that in both Europe and the U.S., there was an increase in returns in 2012; this was when the Kyoto Protocol’s first commitment period ended. However in the U.S., there was a decline in returns in 2016 – when Trump was elected president.

“Investors were less confident in the risk return profiles and the fundamentals around low carbon strategies after the change in administration,” said  Realmuto LaPerla. “We’ve seen since then a roll back of EPA regulations and confusing messages from the SEC around fiduciary duty and incorporating ESG metrics.”

“Investors are cognizant of what’s going on in their region and investing accordingly.”

There’s no one-size-fits-all metric

There’s no doubt about it: decarbonization plays a huge role in investment strategies today. Still, Realmuto La Perla said, it’s important to remember that not every ESG metric is created equal. “Different metrics are important for different industries and firms.”

“What [the big idea is] to dive deeper and really scope research so that we understand and can quantify the relationship for an ESG factor… with other factors in the market. That allows us to identify, and lets us really create the spoke strategies to drive alpha for different portfolio managers and investors in this space.”

Find out how ESG data from Refinitiv can help you to make sound and sustainable investment decisions.

Are you considering decarbonization in your investment strategy? And how can U.S.-based investment managers lower their investment portfolio’s carbon footprint to drive alpha?

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