Mainstream credit portfolios perform better with a lower-carbon tilt, according to new analysis.
A paper published last week by the Anthropocene Fixed Income Institute (AFII) claims that both active and passive low-carbon strategies have outperformed their benchmarks – by 168bp and 16bps per annum, respectively.
The Swedish think-tank ran two portfolios: one passive one based on S&P’s Carbon Efficient US Investment Grade Bond Index, and another hypothetical active strategy based on an internal model from AFII.
Both take a sector-neutral approach, underweighting carbon-intensive issuers within a sector and overweighting less intensive ones.
The former was tested for its performance since 2018, while the latter was only tested from 2024. Both had a Sharpe ratio of around 1.
“The results show pretty robustly that both the passive and active strategy have outperformed,” said Ulf Erlandsson, AFII’s founder, who co-authored the paper with his colleague Kamesh Korangi.
The passive portfolio underperformed during the oil and gas spike that followed the invasion of Ukraine, but Erlandsson noted that it has since rebounded and continued to outperform.
“The argument that investors have a fiduciary duty to remain invested in most polluting oil and gas companies may be valid from an equities perspective, but this research demonstrates that fixed income behaves differently,” he continued.
Erlandsson suggested that this could be because shareholders are pressuring issuers in the sector to maximise their returns and dividends over the short term.
“Some of these companies almost look like they’re in rundown mode, with no plan to survive the transition to a low-carbon economy, but a plan to make money over the next 10 or 15 years,” he told IPE.
“And that plan involves leveraging up their balance sheets by raising bond capital to pay dividends – which is good for the performance of equities, but increases risk on the fixed-income side.”
Erlandsson, who used to be a bond trader for Swedish pension fund AP4, argued that the findings of the analysis brought into question the legitimacy of having carbon-intensive corporate credit portfolios as the default.
“If you’ve been invested in a regular corporate credit strategy – in other words, a high-carbon one – you’re very likely to have lost money compared with the low-carbon equivalent,” he said.
“And if you can’t disprove that investing in lower-carbon issuers achieves a better risk-return ratio, then it becomes your duty as a portfolio manager to explain why you are investing in carbon-intensive ones instead.”
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