Carbon Bias in Index Investing

“Carbon bias on stock markets exposes institutional investors to carbon transition risks”

Many institutional investors seek to increase the sustainability of their investment portfolios. Popular value-weighted stock market indices serve as a benchmark for such active equity strategies. Our research reveals these have a carbon bias, which is due to firms operating in carbon-intensive sectors being more capital-intensive and so more likely to be publicly listed. This bias exposes institutional investors to carbon transition risks and we therefore explore several strategies for investors to reduce such risks in their equity allocation.

Key Takeaways for the Industry

• Actively inform clients and fund participants about how the expected risk-return profile of their portfolio will be influenced by adopting a low-carbon strategy.
• Returns may decrease when moving into green assets to reduce the carbon bias of a portfolio, but exposure to climate risks will decrease too.