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Investors are faced with identifying which companies across industries are best positioned for a new economy shaped by the goals set forth in the Paris Agreement. In this paper, we explore building a Paris-aligned equity strategy as part of a broader multi-asset portfolio and the impact on alpha generation from incorporating sustainable insights.
A capital shift is underway
Asset owners and managers will need to facilitate a reallocation of capital towards technologies, companies or countries that are fundamental in this climate transition.
The link to alpha generation
Increasingly, companies that meet the ambitious goals set out in the Paris Agreement benefit from improvements in profitability, productivity, and alpha potential.
A systematic approach to climate and portfolio goals
Using a model built for the continuous reduction of carbon emissions alongside deep firm-level analysis results in a Paris-aligned portfolio with differentiated returns.
Companies meeting the ambitions set out in the Paris Agreement are increasingly benefiting from higher demand and increased firm value. Climate-aware alphas including carbon resource efficiency, green patents, and corporate target setting are linked to quality measures such as productivity and profitability. Take carbon emissions as an example – firm-level data demonstrates that companies with lower carbon intensity exhibit higher excess returns on average. These companies tend to have a lower cost of capital, higher productivity, and increased efficiency making them better positioned for alpha generation.
Along with analyzing carbon emissions data at the company level, incorporating carbon reduction targets at the portfolio level enhances climate outcomes and adds to portfolio returns. Using a minimum requirement of 50% relative carbon reduction vs. the benchmark along with a 7% per annum decarbonization rate allows investors to achieve a true Paris-aligned portfolio forging a path of continued reduction in carbon emissions.
Decarbonization path of a portfolio
Source: BlackRock, as of June 2021. For illustrative purposes only. The graph shows an illustrative decarbonization path of a Paris-aligned portfolio.
Limiting global warming to well below 2ºC and reaching carbon neutrality by 2050 are sizable goals that are required in order to avoid the devastating impact of climate change. The reallocation of capital towards technologies, companies and countries fundamental for the energy transition calls for an evolved approach to building equity portfolios. In our view, a Paris-aligned framework considering sustainability alongside traditional risk and return objectives is crucial for capitalizing on the economic shift taking place.