Man Institute

Analysis

I NTE LLI G E NT R I

Is Your Portfolio’s Carbon

Constraint Paris-Aligned?
February 2022
Time to read: 12 minutes

The application of carbon constraints has become common practice in ESG portfolios.
Investors often ask us how much below benchmark should carbon emissions/intensity
be in their portfolios. In many ways, the industry has settled on some heuristics. For
example, we have seen most investors ask for 30-50% below benchmark using historical
carbon intensity data. But is that enough to achieve our goals for a cleaner, greener
world? In particular, what does it take for a portfolio to be aligned with the Paris Accord
and net zero?

For institutional investor, qualified investor and investment professional use only. Not for retail public distribution.

Authors

Jeremy Wee, CFA Valerie Xiang

Senior Portfolio Manager, Portfolio Analyst,
Man Numeric Man Numeric

www.man.com/maninstitute

‘‘
To be ‘net zero’, a
portfolio should, in
theory, be relatively
carbon free. This
implies that a portfolio
with a carbon budget
30-50% below
benchmark, a current
industry common
practice, is inadequate So, is a carbon constraint that is 30-50% below benchmark in carbon intensity enough
for a net zero claim.  
1. There are two types of net zero claims being made: 1) Net zero claims by corporations eliminating carbon emissions from their own operations; and 2) Net zero claims
made by investment managers to eliminate emissions from their portfolio holdings. The latter is often some weighted version (based on portfolio holdings) of the former.
2. Source: Furdak, Wee; 2020 CFA Institute. 3. The SBTI budgeting process utilises two key methodologies for budgeting: SDA (Sectoral Decarbonization Approach) and
GEVA (Greenhouse gas Emissions per unit of Value Added). The methodology recognises that some sectors have more available technologies for emissions reduction and
hence apply different transition pathways by sector. For more information, see https://sciencebasedtargets.org/
Introduction
The application of carbon constraints has become common practice in ESG portfolios.
Investors often ask us how much below benchmark should carbon emissions/
intensity be constrained in their portfolios. In many ways, the industry has settled on
simple heuristics. For example, we have seen most investors ask for 30-50% below
benchmark using historical carbon intensity data.
But is that enough to achieve our goals for a cleaner, greener world? In particular,
what does it take for a portfolio 1 to be aligned with net zero and the Paris Accord
1.5-degree goal?
Background
Today, carbon constraints are widely applied in practice using Carbon Disclosure
Project (‘CDP’) data that discloses historical emissions of companies. In a typical
low-carbon portfolio, stocks in carbon-intensive sectors (such as utilities, energy
and materials) are typically penalised. Having said that, the makeup of a low carbon
portfolio is typically not very different from one without the constraints as it is usually
easy to achieve a portfolio with up to 50% carbon intensity/emissions lower than a
typical index. In Carbon Budgeting in Quantitative Managed Portfolios 2 , we describe the
skewness of carbon data and how lower carbon portfolios can be achieved typically by
eliminating just a handful of high-emitting names in the tail exposures of the portfolio.
But is that enough?
Paris Alignment Versus Net Zero
The Science Based Target Initiative (‘SBTI’) – a joint initiative between key players such
as CDP, United Nations Global Compact, World Resources Institute (‘WRI’) and World
Wide Fund for Nature (‘WWF’) – established requirements for the net-zero standard.
One key principle behind the standard is that there should be “no net-zero claims until
long-term targets are met”, which for most companies means long-term target emission
reductions of at least 90-95% by 2050. Hence, to be ‘net zero’, a portfolio should,
in theory, be relatively carbon free. This implies that a portfolio with a carbon budget
30-50% below benchmark, a current industry common practice, is inadequate for a net
zero claim.
While a claim of ‘net zero’ is difficult to achieve in portfolios, we believe that investors
can build portfolios that are on the path to net zero and show alignment to the Paris
1.5-degree goals, by customising portfolios beyond simple carbon budgeting.
to be on the path to net zero?
’’ 2050 is almost 30 years away, and a company committed to net zero should “set
near- and long-term targets” to achieve that goal (another tenet of SBTI’s net zero
principle). There is currently data available that allows investors to explicitly express
that a portfolio is on the path to net zero. As companies commit to net zero, they
register forecast target future emissions by year with the SBTI 3 , alongside the
budgeted emissions allocated. While most companies do not have projections out
to 2050, investors can look at the over-/under-forecast of company emissions into
the near future as an indication of whether a company is on the explicit path to net
zero. The overall portfolio emissions can be further constrained to align the portfolio
to SBTI’s budgeted emissions by utilising quantitative tools. Figure 1 shows two
contrasting utility companies, comparing future expected emissions to budgeted
(aligned) emissions.
Is Your Portfolio’s Carbon Constraint Paris-Aligned? |  2
 Figure 1. Projected Emissions Versus Paris-Aligned Emissions (2012* to 2025)

Above Budget – Utility 1 Below Budget – Utility 2

350

tCO2e (million)

tCO2e (million)
600

300
500

250
400
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150
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100

100 50

0 0

12
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13

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24
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12

14

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25
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20
20
20
20
20
Paris-aligned emissions: Upper Paris-aligned emissions: Upper
Bound 2-degree, Lower Bound 1.5-degree Bound 2-degree, Lower Bound 1.5-degree
Utility 1 carbon emissions Utility 2 carbon emissions

Source: Trucost, SBTI; as of 20 November 2021.

*2012 is the base year of the analysis. Alignment is measured by cumulative above/below constraints since the base year to
2025. Hence, historical emissions are important to the extent that companies are penalised should their actual emissions exceed
projected emissions.

‘‘
While carbon
constraints on
Historical Emissions Do Not Equal SBTI Alignment
While carbon constraints on historical emissions is a first step to achieving greener
portfolios, a lower emissions portfolio is not necessarily more ‘1.5-degree aligned’ than
a higher emissions portfolio (Figure 2). Indeed, as the figure shows, there is very little
historical emissions relationship between carbon intensity (historical) and 1.5-degree alignment (future).
is a first step to Typically, carbon intensity is measured based on a company’s previous year emissions
over sales (ton/USD million). It is a backward-looking measure and does not take into
achieving greener account a company’s future emissions.
portfolios, a lower
emissions portfolio Figure 2. Carbon Intensity Versus 1.5-Degree Alignment

is not necessarily 3.5

1.5-degree emission (Billion)

3.0
more ‘1.5-degree 2.5

aligned’ than a higher 2.0

 ’’
1.5
emissions portfolio.
1.0

0.5

0.0

-0.5

-1.0

-1.5

-2.0
0 2,000 4,000 6,000 8,000 10,000 12,000 14,000 16,000 18,000

Carbon intensity

Source: Trucost, SBTI; as of 20 November 2021.

For example, an SBTI-aligned portfolio can, in many cases, still be invested in energy
and utilities, unlike a low-carbon portfolio that likely avoids these carbon-intensive
sectors. Utility 2, an integrated electric company servicing multiple states, is in many
regards a leader in the sector when it comes to alternative energy. At a carbon
intensity of 450 CO2 ton/USD million (versus the MSCI World at 138 CO2 ton/USD
million), the company is likely to be excluded from many low carbon portfolios (Figure

Is Your Portfolio’s Carbon Constraint Paris-Aligned? |  3

3). However, it is considered by many experts to be a leader in net zero initiatives.
It recently launched a USD20 million Climate Change Investment Initiative, which
includes providing investments to startups developing new technologies to reduce
greenhouse gases. It has been given an A- rating by CDP, and currently derives 43.1%
of its revenues from low-emission nuclear energy. Most importantly, it has significantly
beaten the SBTI 1.5-degree budgeted emissions by 91 million tons of CO2 emissions,
clearly doing more than its fair share of its contribution towards our greener world.

Figure 3. Key Carbon Metrics of Utility 2

Carbon Intensity (CO2 Ton/$million) 450

Cumulative tCO2e (under)/over 1.5-degree Celsius Carbon Budget (2025 Horizon) -91 million
% Revenue from Nuclear Energy 43.1%

Man Numeric Model Scores

Climate Model +3.0
ESG Model +1.1
Environmental Model +1.4

Carbon Intensity
500
(CO2 Ton/USD million revenues)

450

400

350

300

250

200

150

100

50

0
Utility 2 MSCI World

Source: Trucost; as of 20 December 2021.

We would also note that being ‘net zero’ is a much more stringent requirement than
being ‘carbon neutral’. A mega-cap tech firm, for example claims of being “carbon
neutral since 2007”. This is indeed a bold statement. Dig a little deeper, and the
company has achieved carbon neutrality by purchasing renewable energy offsets, while
it continues to emit (based on 2019 data) 5.3 million tons of CO 2 emissions (Scope 1
and 2). This would, of course, be insufficient based on the SBTI’s Net Zero Standard,
which explicitly requires companies to focus on “rapid, deep emission cuts” rather than
achieving net zero by purchasing offsets.

Is Your Portfolio’s Carbon Constraint Paris-Aligned? |  4

 Figure 4. Carbon Emissions, Intensity – Tech Firm

Carbon Emission Carbon Intensity

6 70

tCO2e (million)

tCO2e / USD Million company gross profit

5

60
4

3 50

40
1

0 30
2012 2013 2014 2015 2016 2017 2018 2019 2012 2013 2014 2015 2016 2017 2018 2019

Source: Trucost, SBTI; as of 20 November 2021.

Building a Paris-Aligned Portfolio

A quick study of the SBTI 2-degree alignment data paints a picture that is somewhat
bleak: only 34.3% of companies in the MSCI ACWI Index are aligned with the 2-degree
goal (1.5-1.75 and 2-degree buckets), and a mere 19.5% of companies are aligned
with the 1.5-degree goal (on the path to net zero, Figure 5). 4 A look at emissions
trajectory by sector shows a similar picture where many sectors are also not 2-degree
aligned. For an ESG manager focused on making a difference, it is imperative to
focus on future alignment when evaluating companies for possible investment and/
or engagement. The manager should recognise that certain companies are more
predisposed to higher emissions than others. Instead of punishing the cement or steel
company, it is the company’s future plans for committing resources or capital that are
more important, in our view.

Figure 5. SBTI Emissions Alignment (% Count) by Various Warming Scenarios

Distribution of Alignment - MSCI ACWI Index

60%

50%

40%

30%

20%

10%

0%
1.5-1.75°C 2°C 2.7-3°C 4°C >5°C

Source: Trucost, SBTI; as of 20 November 2021.

4. As of 20 November 2021.

Is Your Portfolio’s Carbon Constraint Paris-Aligned? |  5

 tCO2e (Millions) tCO2e (Millions) tCO2e (Millions) tCO2e (Millions) tCO2e (Millions) tCO2e (Millions)

0
0

20
40
60
80
10
20
30
40
0
100
200
300
400
0
1
2
3
4
5
6
0
5
10
15
0
Sector

100
200
300
400

Region
20 20 20 20 20 20
12 12 12 12 12 12
20 20 20 20 20 20
14 14 14 14 14 14
20 20 20 20 20 20
16 16 16 16 16 16
20 20 20 20 20 20
18 18 18 18 18 18

UK
20 20 20 20 20 20
20 20 20 20 20 20
Energy

Utilities
Financials
20 20 20 20 20 20

Asia ex Japan
22 22 22 22 22 22
20 20 20 20 20 20
24 24 24 24 24 24
Consumer Discretionary

tCO2e (Millions) tCO2e (Millions) tCO2e (Millions) tCO2e (Millions) tCO2e (Millions) tCO2e (Millions)

Source: Trucost, SBTI; as of 20 November 2021.

0
0

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20

20 20 20 20 20 20
12 12 12 12 12 12
20 20 20 20 20 20
14 14 14 14 14 14
20 20 20 20 20 20
16 16 16 16 16 16
Figure 6. SBTI Emissions Trajectory by Sector/Region

20 20 20 20 20 20
18 18 18 18 18 18
20 20 20 20 20 20

Japan
20 20 20 20 20 20
Materials

Real Estate
20 20
Technology

20 20 20 20
22 22 22 22 22 22

Emerging Markets
Consumer Staples

20 20 20 20 20 20
24 24 24 24 24 24

tCO2e (Millions) tCO2e (Millions) tCO2e (Millions) tCO2e (Millions) tCO2e (Millions)
0
5

0
0
10
15
20
25
30

0
1
2
3
4
5
6
0
1
2
3
4

10
20
30
40
50
20
40
60
80

Paris-aligned emissions: Upper Bound 2-degree, Lower Bound 1.5-degree

Paris-aligned emissions: Upper Bound 2-degree, Lower Bound 1.5-degree
20 20 20 20 20
12 12 12 12 12
20 20 20 20 20
14 14 14 14 14
20 20 20 20 20
16 16 16 16 16
20 20 20 20 20
18 18 18 18 18

US
20 20 20 20 20

Emissions
Emissions
20 20 20 20 20

Europe
Industrials

20 20
Health Care

20 20 20
22 22 22 22 22
20 20 20 20 20
24 24 24 24 24
Communication Service

Is Your Portfolio’s Carbon Constraint Paris-Aligned? |  6

‘‘
Similar to historical carbon emissions data, careful attention also needs to be
paid to the distribution of the data and the implications of applying the data as
another constraint.
We believe it is Most importantly, and very much like applying carbon constraints, we believe it is
possible to build portfolios with a 1.5-degree alignment constraint that do not have
possible to build
significant industry and factor biases. This is in spite of the fact that only 19.5% of
portfolios with a companies in the MSCI ACWI Index meet this requirement. Thankfully, the skewness in
the data allows the emissions of companies above budget to be offset with companies
1.5-degree alignment
that are meaningfully below budget (Figure 7). In addition, larger-cap companies
constraint that do also tend to be the companies under budget, making it easier for us to achieve the
constraint for portfolios tethered to cap-weighted indices. Going forward, we believe
not have significant
this goal should be easier to achieve as more companies commit to having their
industry and factor operations net zero and as more technology becomes available to help them achieve
those goals.
biases. This is in spite
of the fact that only
Figure 7. Distribution of Various Warming Scenarios: Tons CO2 (Under)/Over Budget
19.5% of companies
tCO2E (Under)/Over 1.5-1.75°C Carbon Budget: 2012-2025
in the MSCI ACWI 4
tCO2e (Billions)

Index meet this 3

requirement.  ’’ 2

-1

-2

tCO2E (Under)/Over 2°C Carbon Budget: 2012-2025

4
tCO2e (Billions)

-1

-2

tCO2E (Under)/Over 5°C Carbon Budget: 2012-2025

4
tCO2e (Billions)

-1

-2

-3

Source: Trucost, SBTI; as of 20 November 2021.

Indeed, while the weight of companies in benchmark that are 1.5-degree aligned is less
than 30% (Figure 8a), we can build a portfolio that has a meaningful different projected
emissions alignment (Figure 8b) compared with the benchmark. In our hypothetical
portfolio, the weighted average overall carbon emissions in a 1.5-degree warming
scenario is below zero (under budget), compared with the benchmark, which is more

Is Your Portfolio’s Carbon Constraint Paris-Aligned? |  7

than 10 million cumulative tCO2e over the 1.5-degree budget (2025 horizon). In fact,
very much like carbon constraints, our research indicates that the resulting portfolio
has: 1) no meaningful sector tilts; 2) no noticeable impact on performance; and 3) no
significant style drift: an interesting outcome given the percentage of companies in the
universe that are Paris-aligned.

Figure 8. Hypothetical ACWI Climate Portfolio Versus MSCI ACWI Benchmark

8a) Percentage Weight Alignment Under Various Warming Scenarios

65%

60%

55%

50%

45%

40%

35%

30%

25%
1.5°C_or_1.75°C_ 2°C_aligned 2.7°C_or_3°C_ 4°C_aligned 5°C_aligned
aligned aligned

Portfolio Benchmark

8b) Emission-based Alignment Under Various Warming Scenarios

15
Millions

10

-5

-10

-15

-20
1.5°C_or_1.75°C 2°C 2.7°C_or_3°C 4°C 5°C

Portfolio Benchmark

Source: Trucost, SBTI; as of 30 November 2021.

The above contains hypothetical or simulated model results that have certain inherent limitations. Unlike an actual portfolio
record, simulated results do not represent actual trading. Also, since the trades have not actually been executed, the published
results may have under-or-over compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated
trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. There exist limitations
inherent with model results. Results include simulated transaction costs, but do not include the impact of actual trading.

Conclusion
Building a 1.5-degree aligned portfolio is very much like building a portfolio with a
carbon constraint, in our view. The skewness in the data allows for portfolios – that are
aligned with almost no noticeable industry and factor biases – to be built.

To be successful, however, we believe investors should choose managers that: 1) have

a tangible track record of building portfolios with carbon budgets; and 2) are equipped
with all the necessary tools to build 1.5-degree aligned portfolios that minimise the
impact on other portfolio objectives.

Is Your Portfolio’s Carbon Constraint Paris-Aligned? |  8

Authors

Jeremy Wee, CFA

Senior Portfolio Manager, Man Numeric
Jeremy Wee is a senior portfolio manager at Man Numeric. He
leads the day-to-day management of the US and global portfolios
and assists in managing other strategies. Jeremy also conducts
research on model and process improvements for these strategies.
He is also a member of the Man Group Responsible Investment
Committee. Prior to joining Man Numeric in 2014, he was a portfolio manager at
Batterymarch Financial Management for emerging markets and global managed
volatility strategies. Prior to that, Jeremy held portfolio management and quantitative
research roles at Blackstone and Citigroup Asset Management. Jeremy received a
bachelor’s degree in computer engineering from the University of Michigan and an MBA
from the Massachusetts Institute of Technology Sloan School of Management. Jeremy
is a CFA charterholder.

Valerie Xiang
Portfolio Analyst, Man Numeric
Valerie Xiang is a portfolio analyst at Man Numeric. Prior to joining
Man Numeric in 2019, Valerie worked at Panagora and Citigroup
Global Markets. Valerie received a bachelor’s degree in economics
from Fudan University and master’s degree in finance from
Massachusetts Institute of Technology.

Is Your Portfolio’s Carbon Constraint Paris-Aligned? |  9

Hypothetical Results
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Is Your Portfolio’s Carbon Constraint Paris-Aligned? |  10