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Environmental Impact and Outperformance

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Environmental Impact and Outperformance


A data-driven approach to integrating Carbon Footprinting into the Investment Process

Environmental, social and governance issues are at the forefront of many, if not all, corporations’ minds as we enter the new decade. The rise of ESG awareness amongst corporate management, and the investors who finance them, has been undeniable, with some $137.3 billion allocated specifically to ESG-focused investments funds as of the start of 2020.

Whether due to an increasing frequency of climate-related events, focused international regulation and initiatives such as the Paris Agreement (2016) and TCFD Reporting, or the increasing availability of data detailing company climate impact, the ‘E’, or environmental issues, have come to the forefront of recent ESG discussions. Nowhere was this more concisely evidenced than by the January 2020 release of ‘A Fundamental Reshaping of Finance’, Larry Fink’s letter putting forth BlackRock’s expectations for company environmental disclosures, advising effect from this year. 

Still, even when dealing with a more focused set of environmental metrics, the jury is still out on the optimum method of integrating ESG into the investment process. Here, we outline an approach that expands a traditional method of portfolio construction with factors based on environmental data directly linked to companies’ financial performance. We conclude that:

a) An integrated carbon-friendly approach to portfolio construction need not necessarily involve a trade-off between prioritizing risk-adjusted returns and environmental impact. Environmental costs, as an increasingly important factor of business performance valued by investors, can potentially enhance performance across a global investment strategy while significantly reducing portfolio carbon intensity.

b) Implementing an integrated carbon-friendly investment process by adding an environmental factor overlay to a simple ‘growth at a reasonable price’ strategy exhibits incremental historic outperformance, while also significantly reducing portfolio carbon intensity relative to the benchmark. We pose that many existing strategies can benefit from an environmental factor overlay.

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