Carbon Negative Leveraged Investment Strategies

Abstract

Measuring the impact of portfolio allocations in terms of non-pecuniary effects is becoming more mainstream in the financial industry. A logical extension to methodologies such as portfolio carbon footprinting is that more or less capital provisioning through leverage or short positions should have increased/negative non-financial effects as well. Focusing on climate impact, this paper develops a stylized model where investor capital allocations drive total economy carbon emissions, and derive the carbon footprint attributable to the investor. In the model, using leverage in the form of long-short short strategies, the investor can reduce or even make their footprint negative when their investment allocations drive (shifts of) cost-of-capital and full economy emissions reductions. In an empirical application using the iTraxx Main non-financial index, we demonstrate how a generic corporate bond exposure can achieve a zero or negative carbon footprint by using a leveraged long-short overlay. The findings should be useful in terms of repositioning traditional non-impact portfolios by using overlays as well as to validate and leverage already operational ESG strategies.