Russell Investments has released new research that identifies how investors can reduce the carbon footprint of their portfolios without affecting investment performance.
In a report titled Portfolio Decarbonisation Strategy, Russell Investments flagged three common decarbonisation strategies: divestment, sector-neutral reallocation and risk model optimisation
The report follows work undertaken with industry fund HESTA, whereby Russell Investments was engaged to deliver a new low-carbon, global equity investment strategy.
Russell Investments director of equity strategy and research Scott Bennett said: “The research validated our unique outcome-oriented approach developed to achieve a greater than 50 per cent reduction in the carbon footprint and deliver benchmark-like returns.”
In terms of sector-neutral reallocation, an investor must remove the highest-carbon-footprint securities within a sector. To maintain sector weight, the investor must then reweight the securities within the sector on a pro-rata basis.
“Sector neutral reallocation should overcome the sector and industry biases that we see in the standard divestment approach,” the report said.
Risk model optimisation, the report said, is a strategy that uses risk model-based optimisation that seeks to minimise the carbon footprint while keeping ex-ante tracking error at less than 30 basis points.
“Risk model optimisation should be very effective in reducing the aggregate carbon footprint of a portfolio and also in managing ex-ante tracking error.”
In addition, the report pointed out that decarbonisation presents both challenges and opportunities for investors.
“The opportunity is that we can reduce the aggregate carbon footprint of a portfolio by adjusting the weight of a relatively small number of companies,” it said.
“The challenge is that this small number of companies is concentrated in a narrow set of sectors, and altering sector allocations may impact portfolio returns.”
“If we reduce carbon footprint, we may induce active negative exposures to one or more of these sectors and/or industries, and consequently subsequent active positive exposures to other sectors and/or industries to make up the difference,” the report said.