Vol. 20, No. 4, 2022
by Ashwin Alankar and Myron Scholes
Two common methods that portfolio managers use to reduce the carbon footprint of their portfolios are either to exclude carbon emitters from their portfolios or to engage/cajole underlying companies to reduce their carbon footprint by taking actions to reduce emissions. We estimate the costs of excluding carbon emitters from a portfolio. We highlight the costs and benefits of a third alternative that seeks to preserve the separation principle such that managers select their optimal portfolio based on return and risk optimizations, and separately incur transaction costs to satisfy investors’ demands toward “net zero” by purchasing carbon credits to offset the carbon footprint of their optimal portfolios. By doing so, although the composition of the portfolio may contain carbon emitters, the portfolio itself is carbon neutral. To acquire these carbon credits efficiently either directly or in secondary markets requires asset management skills. We believe that investors in mutual funds or ETFs would determine their own preferences toward carbon “net zero” by buying a combination of a fund that offsets fully emissions of the companies in the underlying portfolio and another(a clone of the other)that did not.