Carbon Risk Integration With Factors

Abstract

Integration of carbon risks into the investment process requires careful analysis of risk-return characteristics and factor exposures of resulting carbon efficient portfolios. In this article, we propose a stylized framework to integrate traditional style factors with carbon efficient portfolios for both U.S and developed Europe markets. The results show that although carbon efficient factor portfolios do achieve the objective of lowering carbon intensity, they generally have lower risk-adjusted returns than the pure factor portfolios. In addition, carbon efficient factor portfolios have lower exposure to the targeted factors, and the reductions in factor exposure are statistically significant.