Specialist in Asia Pacific, Japan, China, India and South East Asia and Global Emerging Market equities.

Discover more

formerly Realindex Investments

Leader in active quantitative equities across Australian equities, global equities, emerging markets and global small companies.

Backed by a unique blend of research, portfolio construction and risk management, focused on uncovering original insights and translating them into investment strategies that are active and systematic, aiming to generate alpha.

Discover more

At Stewart Investors, we believe in putting people first. Our investment world-view is of a series of partnerships – with each other, with our clients, with the companies we invest in, the people who buy their goods and services, and with the wider society in which we all live and work.

Discover more

Reduce carbon without sacrificing returns – can investors have it all?

From net zero pathways to climate action to the perils of greenwashing, the business headlines do not always paint a positive picture for investors pursuing strong returns in their portfolios with a sustainability agenda in mind.

Climate change isn’t going away and although it feels like a battle to be fought by governments, businesses and fund managers, the truth is that the drive for climate action is much closer than you think, at least in your investment portfolio. Increasingly, fund managers recognise the transition to net zero as both a risk to control and a potential source of investment opportunities1, while aligning portfolios with a net zero trajectory. For investors, there is potential to drive a powerful trend towards greater climate action by selectively investing in funds.

Top of mind for most investors, however, is whether exposure to the decarbonisation megatrend sacrifices returns. Can we have it all? The answer actually is yes, but it’s also complicated.

A word on tracking error

While rarely considered by average investors, tracking error is an important measure to assess how closely to the benchmark a portfolio will likely perform – broadly speaking, it measures the width of the bell curve of annual portfolio performance relative to the benchmark. Of course, the more a portfolio’s allocations differ from a benchmark, the higher the tracking error is likely to be.

For investors who want to incorporate environmental, social and governance (ESG) characteristics, like reduction in carbon emissions, into their portfolio but with a preference for benchmark-type risk and returns, low tracking error is important.

Intuition suggests that reducing carbon intensity would have a marked effect on tracking error, and perhaps returns. Our analysis tells a surprising story.

Reallocating within rather than out of sectors

Investors wanting to integrate decarbonisation into their overall investment strategy might consider sector exclusions or divestment of companies that generate significant carbon emissions. Selling down positions in companies in the highest carbon intensive sectors can get investors the biggest carbon intensity reductions, but it can also introduce more portfolio risk and tracking error, as well as having a material impact on returns.

However, it is possible to achieve carbon reductions in a portfolio without necessarily selling out of a sector. To do this in a controlled way, we use each stock’s carbon intensity as our central measure (carbon intensity is Scope 1 and 2 greenhouse gas emissions per million dollars of sales.). This scores stocks strictly on their emissions through their operations and is agnostic to the value of a company.

Within individual sectors or industries, it is worth noting that stocks have broad ranges of carbon intensity – many stocks with little or no carbon intensity and a few stocks with a great deal. Indeed, in most sectors of the global stock market, we found that a 30% reduction in carbon intensity could be achieved by excluding less than 10% of the stocks by value – energy was the exception, requiring 11.5% to be excluded.  

Our central analysis – and our main results – show that it is possible to achieve moderate levels of carbon intensity reduction in a portfolio with minimal addition of tracking error. By ‘trading up’ for carbon leaders – those with less carbon intensity – within the same sector or industry instead of shifting sector weights when reallocating portfolios, we also found that there is little effect on portfolio alpha, the return generated above that of the benchmark.

Aussie carbon disadvantage

Different geographies will offer different opportunities for reductions in carbon intensity and tracking error for investors.

Perhaps not surprising is the finding that it is more challenging to decrease carbon intensity with minimal addition of tracking error in Australian equities portfolios. This reflects the concentration of higher carbon intense sectors in the Australian index compared to broader global equities indices.

Compare Australian portfolios to global portfolios that have a larger stock universe. In global, we find surprisingly small tracking error for quite large reductions in carbon intensity. For example, a 40% reduction in carbon intensity in MSCI ACWI ex-AU, an international equity index excluding Australian stocks, would only have generated a historic tracking error of 0.10% p.a in the period of December 2008 to June 2022.

For Australia, with a smaller and more resource-oriented market, the impact is higher. For example, decreasing carbon intensity by 30% for the ASX200 adds about 0.50% p.a. of tracking error. This can hamper an investor’s ability to rotate to stocks with less carbon intensity within a sector because there are less options to do so.


For the carbon conscious investor, aligning to the net zero agenda is possible with minimal risk and reward implications in reallocating portfolios. Our study found that moderate adjustments towards lower carbon stocks in well-diversified portfolios can result in substantial carbon intensity reductions with minimal addition of tracking error.

1 For example, there are 301 signatories representing USD 59 trillion in AUM to the Net Zero Asset Managers initiative. This is an international group of asset managers committed to supporting the goal of net zero greenhouse gas emissions by 2050 or sooner, in line with global efforts to limit warming to 1.5 degrees Celsius, and to supporting investing aligned with net zero emissions by 2050 or sooner.

Important Information

This material has been prepared and issued by First Sentier Investors (Australia) IM Ltd (ABN 89 114 194 311, AFSL 289017) (FSI AIM, Realindex), which forms part of First Sentier Investors, a global asset management business. First Sentier Investors is ultimately owned by Mitsubishi UFJ Financial Group, Inc (MUFG), a global financial group. A copy of the Financial Services Guide for FSI AIM is available from First Sentier Investors on its website.

This material contains general information only. It is not intended to provide you with financial product advice and does not take into account your objectives, financial situation or needs. Before making an investment decision you should consider, with a financial advisor, whether this information is appropriate in light of your investment needs, objectives and financial situation.

Any opinions expressed in this material are the opinions of the individual author at the time of publication only and are subject to change without notice. Such opinions: (i) are not a recommendation to hold, purchase or sell a particular financial product; (ii) may not include all of the information needed to make an investment decision in relation to such a financial product; and (iii) may substantially differ from other individual authors within First Sentier Investors.

To the extent this material contains any environmental, social and governance (ESG) related commitments or targets, such commitments or targets are current as at the date of publication and have been formulated by Realindex based on the Institutional Investors Group on Climate Change (IIGCC) Paris Aligned Investment Initiative framework. The commitments and targets are based on information and representations made to Realindex by portfolio companies (which may ultimately prove not be accurate), together with assumptions made by the relevant investment team in relation to future matters such as government policy implementation in ESG and other climate-related areas, enhanced future technology and the actions of portfolio companies (all of which are subject to change over time). As such, achievement of these commitments and targets depend on the ongoing accuracy of such information and representations as well as the realisation of such future matters. Any commitments and targets set out in this material are continuously reviewed by Realindex and subject to change without notice.

We have taken reasonable care to ensure that this material is accurate, current, and complete and fit for its intended purpose and audience as at the date of publication. To the extent this material contains any measurements or data related to ESG factors, these measurements or data are estimates based on information sourced by the relevant investment team from third parties including portfolio companies and such information may ultimately prove to be inaccurate. No assurance is given or liability accepted regarding the accuracy, validity or completeness of this material and we do not undertake to update it in future if circumstances change. No part of this material may be reproduced or transmitted in any form or by any means without the prior written consent of Realindex.

Any performance information has been calculated using exit prices after taking into account all ongoing fees and assuming reinvestment of distributions. No allowance has been made for taxation. Past performance is not indicative of future performance.

Copyright © First Sentier Investors, 2023

All rights reserved.