Carbon: a new performance vector on the equity markets
Equity management based on specific performance factors is enjoying growing recognition among investors. Exposures to market anomalies which are statistically identified and explained through behavioural or regulatory biases generates over-performance.
Five key factors are highlighted by the world of academic finance as well as practitioners: growth vs value, high vs low momentum, small vs big caps, low vs high volatility, high vs low quality. Some factors are more prevalent than others at certain times depending on market conditions.
Until 2014, the academic literature did not recognise the existence of a low vs high carbon footprint factor on the equity markets that was significant or sufficiently stable in terms of risk-adjusted return. However, the presence of a risk premium on the anticipated profitability of high-carbon companies is identified as well as the fact that transparency of information on carbon emissions benefits the valuation and liquidity of these companies.
Nevertheless, by analysing the most recent data on global equity markets, it seems that the carbon factor is about to become an important source of performance. Considering the universe of the MSCI ACWI index, two portfolios are set up depending on companies’ carbon footprints: a low carbon portfolio with the quarter of the companies presenting the lowest carbon footprints, and a high carbon portfolio with the quarter of the companies presenting the highest carbon footprints. Over the past four years, the low carbon portfolio has generated an outperformance of 2.9% relative to the high carbon portfolio with a lower level of volatility. Compared to the MSCI ACWI index, the low carbon portfolio’s performance is 1.9% higher and the high carbon portfolio 1% lower.
The presence of a carbon factor on global listed real estate is even more long-dated and more significant. Considering the EPRA Global index, a low carbon portfolio, made up of half the stocks presenting the highest environmental rating, has generated a performance 5.0% higher than the index over the past 11 years for an equivalent level of volatility.
The carbon factor is definitely a performance element to be taken into account in the management of a portfolio invested in equities, and even more so in listed real estate. For the latter, it is actually not so surprising as 40% of anthropogenic emissions of greenhouse gases come from the building sector. Considering the differences in performance between low and high carbon portfolios, the equity market is implicitly pricing the carbon at around €100 per tonne, anticipating future taxation or the implementation of a real emission rights market.