A Stitch in Time Saves Nine – EU Emission Allowances as a Transitory Tool for Net Zero Equity Portfolios

Carbon markets have recently received increased attention owed to soaring prices on the one hand but also due to the potential environmental benefits investors can achieve by engaging in these markets.

In this whitepaper, we demonstrate how investors can make use of EUAs to offset financed emissions of equity portfolios providing a step-by-step implementation methodology, practical examples, analysis of such implementation for different portfolios, and a discussion of practical considerations:

• Decarbonizing Solactive’s Developed Markets Paris Aligned Benchmark (PAB) by such means takes a 0.8% – 3.8% portfolio allocation to EUAs depending on which emission scopes are considered and how emissions are allocated between equity and bond holders. Corresponding allocations for European and Emerging Markets climate strategies range from 1.4% – 5% and 2.5% – 10.4%, highlighting the different emission levels in the examined regions.
• Adding EUAs to the equity portfolio results in improved risk/return profiles exemplified by higher return and lower volatility. Further analysis shows low correlations between EUA and equity market returns hinting at diversification benefits of adding carbon allowances to existing portfolios.
• EUAs represent a high-quality, regulated and thus viable alternative to commonly used carbon offsets addressing some of their key points of criticism.