How the Paris Agreement is reshaping equity investing

Overview

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 potential alpha generation from incorporating sustainable insights.

Climate-aware alpha drivers

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.

A critical step to net zero: Decarbonization

Along with analyzing carbon emissions data at the company level, incorporating carbon reduction targets at the portfolio level can enhance 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

Capitalizing on the climate transition

Limiting climate change to well below 2ºC and reaching carbon neutrality by 2050 are sizable goals that are required in order to avoid the potentially 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.