- Some investors may be focused on reducing portfolio carbon emissions while keeping their exposure to energy stocks.
- In our study period, portfolio emissions were reduced but faced trade-offs in the form of higher tracking error, higher turnover and more concentrated portfolios than the MSCI ACWI IMI Energy Index.
- Emissions were lowered by underweighting high-emitting energy sub-sectors while overweighting low-emitting sub-sectors.
With the world increasingly focused on a net-zero future, portfolio managers face new challenges as they seek to reduce portfolio carbon emissions while delivering competitive risk-adjusted returns relative to energy benchmarks, such as the MSCI ACWI IMI Energy Index.
Diverse priorities: energy and emissions
In particular, how can portfolio managers maintain their exposures to the energy sector, which is one of the highest-emitting sectors that also outperformed the global equity market year to date,1 while also seeking to reduce carbon emissions? The MSCI ACWI IMI Energy Index returned 15.15% from Dec. 31, 2021, to Sept. 30, 2022, versus -25.43% for the MSCI ACWI IMI parent index.
In our study period from June 30, 2020, to Sept. 30, 2022,2 we found that portfolios could have reduced portfolio emissions — but with trade-offs.3 Let’s look at a sub-portfolio4 based on the MSCI ACWI IMI Energy Index that imposes constraints on portfolio emission intensity while rebalances monthly.
MSCI ACWI IMI Energy Index emission intensity by GICS® sub-industry
GICS is the global industry classification standard jointly developed by MSCI and S&P Global Market Intelligence. Data as of Sept. 30, 2022.
Digging deeper
In the MSCI ACWI IMI Energy Index, coal and consumable fuels had the highest emission intensity among sub-industry sectors, while oil and gas storage and transportation had the lowest intensity, as of Sept. 30, 2022. Integrated oil and gas had the highest weight and contributed the most to the Index-level emission intensity, while oil and gas drilling has the lowest weight and contributed the least to the Index-level emission intensity.
Portfolio emission reduction vs. tracking error and Sharpe ratio
| Portfolio emission- intensity reduction |
10% | 20% | 30% | 40% | 50% | 60% | 70% | 80% |
| Emission Scopes 1+2+3 intensity /t/USD million EIVC) as of 09/30/22 |
2,992 | 2,668 | 2,327 | 1,995 | 1,662 | 1,330 | 997 | 670 |
| Financed Emission Scope 1+2+3 (billion tons) |
8.3 | 7.4 | 7.0 | 5.4 | 4.5 | 3.6 | 2.8 | 2.0 |
| Cumulative portfolio return | 88.6% | 89.8% | 89.1% | 89.9% | 88.8% | 86.4% | 84.7% | 84.1% |
| Avg # of assets | 281 | 227 | 184 | 157 | 137 | 122 | 114 | 109 |
| Sharpe ratio (left axis) | 1.14 | 1.16 | 1.15 | 1.17 | 1.17 | 1.15 | 1.14 | 1.13 |
| Tracking error % (right axis) | 0.48 | 0.85 | 1.17 | 1.84 | 2.65 | 3.56 | 4.56 | 5.65 |
Data from June 30, 2020, to Sept. 30, 2022.
In this example, we reduced the portfolio’s carbon emission intensity (in 10% increments) and financed emissions, with minor effects on its risk-adjusted return (as measured by the portfolio’s Sharpe ratio). The trade-offs came in the form of higher tracking error, higher turnover and more concentrated portfolios.
The emission reduction was achieved by underweighting emission-intensive GICS sub-industries like coal and consumable fuels, oil and gas refining and marketing, and integrated oil and gas.5
Energy considerations over time
In practice, managing portfolio carbon emission takes into consideration not only recent, historical emission intensities and financed emissions, but also the projections measured by forward-looking climate metrics, such as Implied Temperature Rise. We will discuss this dilemma of balancing short-term and long-term objectives in the next blog post in this series.
1This period encompasses Russia’s invasion of Ukraine, which started on Feb. 24, 2022.
2Energy sector’s emissions are mostly from Scope 3, which became available in June 2020. The lack of earlier data makes it impossible to simulate meaningful results for prior periods.
3The analysis and observations in this report are limited solely to the period of the relevant historical data, backtest or simulation. Past performance — whether actual, backtested or simulated — is no indication or guarantee of future performance. None of the information or analysis herein is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision or asset allocation and should not be relied on as such.
4The sub-portfolios were based on the MSCI ACWI IMI Energy Index with constraints on portfolio emission intensity while rebalanced monthly with the goal of minimizing tracking errors. Russian assets were excluded due to delisting earlier this year.
5For example, the simulated sub-portfolio as of Sept. 30, 2022, whose emission intensity was 90% of the emission intensity of its benchmark, underweighted the GICS sub-industries of coal and consumable fuels, oil and gas refining and marketing, oil and gas exploration and production, integrated oil and gas, and oil and gas drilling; while overweighting oil and gas equipment and services, and oil and gas storage and transportation.
Further Reading
Decarbonizing Bond Portfolios: Risk Trade-Offs
Net-Zero Alignment: Managing Portfolio Risk Along the Net-Zero Journey
Implementing Net-Zero: A Guide for Asset Owners
Analytical Framework for a Net-Zero Journey
Despite Energy Outperformance, Climate Indexes Were Resilient