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.