Building benchmarks portfolios with decreasing carbon footprints

BIS Working Papers  |  No 985  | 
16 December 2021



An increasing share of investors and asset managers are looking for ways to trim the carbon footprint of their investments. We describe simple approaches that will help a passive investor make such reductions, whether in a world-wide or a regional portfolio of stocks. Of particular interest is whether investors would need to divest away from emerging market economies or high-emissions sectors such as energy, utilities and cement to reduce their carbon footprint.


We analyse simple allocation rules that exclude corporates whose carbon footprint is above a given threshold for any given year, with the aim of meeting the investor's targeted emissions reductions. We report how many stocks are excluded and assess various ways of reinvesting the proceeds. We then compare the financial performance of the business-as-usual benchmarks with that of our alternative net zero-consistent ones.


We show that a passive investor could have cut the carbon emissions of their portfolio by 10% every year for the past 10 years with relative ease and without changing its country or sectoral exposure. A cumulated reduction of 64% of carbon emissions with respect to the 2010 MSCI global stock portfolio could be reached in 2019 by excluding about 11% of the most polluting corporates, which collectively account for 6% of market capitalisation, and without reducing exposure to any one country or sector. The returns and Sharpe ratio of the business-as-usual MSCI benchmark and the alternative net zero-consistent ones are almost identical.


In this paper, we build portfolios with a progressively falling carbon footprint, which passive investors could use as a new Paris-consistent (PC) benchmark while keeping their risk-adjusted returns at the same level as those of business-as-usual (BAU) benchmarks. We identify the worst polluters globally, exclude them from the portfolio, and re allocate the proceeds so as to keep sectoral and regional exposures similar to those of the business as usual (BAU) benchmark. This approach limits the divestment from corporates in emerging market economies that would result from implementing exclusions and reinvestment without the objective of preserving regional exposures. We show that reducing the carbon footprint of the portfolio by 64% in 10 years could be achieved by sequentially excluding up to 11% of the corporates, which together amount to less than 6% of the global market portfolio. While this reallocation keeps regional and sectoral exposures at a similar level to those of the BAU benchmark, it does not change the portfolio's risk-adjusted return. We define PC benchmark portfolios at the global level as well as for Emerging Countries, Europe, North America, and the Pacific.

JEL classification: G11, G24, Q56.

Keywords: Portfolio carbon footprint, Green and brown assets, Alignment with Paris Net Zero Emissions Agreement.