(De)-Carbonara: A Better Recipe for Reducing Emissions

Introduction

Despite the urgent need to address climate change, global carbon emissions continue to rise (Figure 1, left-hand side). While investors have the power to catalyse real-world decarbonisation through their portfolios, a paradox emerges: even as the weighted average carbon intensity (WACI) of standard indices decreases (Figure1, right-hand side), global emissions keep climbing. This highlights a critical gap – capital is not flowing to high-emission sectors where decarbonisation impact is most urgently needed but is instead staying in sectors with low emissions to avoid being perceived as contributing to climate change.

Figure 1: Global CO2 emissions keep rising, even as investors decarbonise their portfolios 

Note: Left-hand side chart shows the increase in global CO2 emssions from energy combustion and industrial processes, while the right-hand side chart highlights developments in the MSCI ACWI weighted average carbon intensity. Source: Left-hand side: International Energy Agency, 2025.¹  Right-hand side: Sustainalytics, MSCI, S&P Trucost Limited © Trucost 2025.

Achieving net zero requires the reverse – investing in high-emitters and then changing business practices to lower emissions. In our view, this also may offer an opportunity to deliver excess returns while driving measurable emissions reductions in the real economy.

Much like cooking the perfect spaghetti carbonara, decarbonising a portfolio relies on a simple recipe that must be well executed. We begin by examining the science behind portfolio versus real world decarbonisation before outlining a three-step framework for decarbonisation investing. Our first step is to construct a climate-relevant universe, focusing on subindustries most relevant to the low-carbon transition. In the second step, we look to select stocks which may generate alpha via decarbonisation, with quantifiable decarbonisation outcomes, using our proprietary signals. Finally, we systematically and simultaneously optimise for three objectives: returns, real-world decarbonisation outcomes and risks, to deliver an optimised portfolio. In addition, we further explore how customised constraints (including WACI constraints) could be integrated into individual portfolios to achieve similar outcomes.

Lower WACI ≠ real emissions reduction

Research from Man Group, in collaboration with Columbia University's Center on Sustainable Investment,² suggests that traditional "paper decarbonisation" – reducing portfolio emissions by avoiding high-carbon sectors – actually undermines real-world climate goals. Real-world decarbonisation, by contrast, prioritises financing emissions reductions over reducing financed emissions.³

Despite this evidence, many funds are underweight heavy-emitting sectors to achieve lower WACI portfolios. However, this approach may be counterproductive to actual emissions reduction. Research demonstrates that increasing the cost of capital for high-emitting "brown" firms paradoxically causes them to pollute more per unit of output, while providing cheaper capital to "green" firms yields minimal emissions reductions.⁴ This suggests that capital allocation strategies focused solely on avoiding brown sectors may inadvertently worsen environmental outcomes.

In the example below (Figure 2), the decarbonisation portfolio example is more carbon intensive relative to a peer climate-transition-labelled fund due to greater exposure to high-emitting sectors. However, companies within the decarbonisation portfolio on average experienced a 22% reduction in absolute carbon emissions over three years, whereas in the peer climate-transition fund, companies saw an increase of 5% in the same period. This historical example suggests that excluding heavy emitters does not contribute to real-world decarbonisation outcomes – instead, systematically selecting heavy-emitting transition leaders may.

Figure 2: High WACI decarbonisation portfolio example versus low WACI transition fund⁵

Source: S&P Trucost Limited © Trucost 2025.

Building portfolios with decarbonisation in mind

1. Universe construction: where decarbonisation matters most

Effective decarbonisation investing begins with understanding where climate impact actually happens. Rather than applying blanket exclusions to high-emitting industries, a systematic approach segments the investment universe based on climate relevance and transition potential.

Figure 3: High and low impact universe

Source: Schematic illustration

Within the global universe, companies can be categorised into distinct climate-impact segments. The High Climate Impact Universe encompasses subindustries most relevant to the low-carbon transition, while the Low Climate Impact Universe contains securities with limited relevance to decarbonisation efforts.

The High Climate Impact Universe further divides into two critical categories:

1. Solutions: companies producing products or services that directly address real-world decarbonisation, such as renewable energy producers and clean technology innovators
2. Transition: companies actively adapting their business models to facilitate the energy transition, typically in traditionally high-emitting sectors like Utilities, Industrials, and Materials

This segmentation enables targeted allocation to companies where capital deployment may drive the greatest climate impact, rather than simply achieving the lowest current emissions profile.

2. Enhancing decarbonisation with alpha flavours

The integration of climate considerations with alpha generation requires thoughtfully constructed signals that go beyond traditional environmental, social and governance (ESG) metrics. Six proprietary decarbonisation signals are outlined below:

Figure 4: Decarbonisation alpha

Signal construction can be modified to align with the specific characteristics of solutions and transition companies. For example, transition companies can be measured for the change in net green revenue as they gradually transition, while solutions companies are measured for the net level they produce. This differentiation enables precise identification of companies that may drive substantial outcomes through different practices.

3. Optimisation: systematic advantage over discretionary approaches

A systematic approach allows for simultaneous integration across three objectives: returns, quantifiable decarbonisation outcomes, and risks in portfolio construction. This is a unique advantage for the systematic process.

Because we quantify the decarbonisation outcomes, they are hence measurable and can be treated together with other quant signals. Similarly, risk models neutralise alpha models against structural risk biases through statistical approaches that identify and adapt to changing market dynamics – including inflation, trade wars, and commodity shocks – that cause unexpected correlations. Top-down sectoral and regional constraints are also integrated into the process, providing optimised portfolio construction.

Parmesan or not? Customisation on constraints

Like choosing whether to add parmesan to our dish, investors can easily select the exposure to decarbonisation and other constraints that align with their objectives, while maintaining alpha.

For example, a pure decarbonisation approach maximises real-world decarbonisation through higher tracking error tolerance. This approach only invests in the high climate impact universe and prioritises climate impact over benchmark tracking, suitable for investors with strong sustainability mandates and higher risk tolerance.

In contrast, a beta plus approach blends decarbonisation signals with traditional alpha generation that results in lower tracking error and broader diversification across both high and low climate impact universe. This approach appeals to asset owners seeking both climate impact and consistent relative returns.

Both variations have delivered excess returns and greater decarbonisation outcomes relative to MSCI World in historical simulations (Figures 5-7).

Constraint customisation extends beyond risk parameters to address specific requirements, such as restricting socially harmful companies and implementing carbon constraints. The systematic framework enables implementation of these customisations, without compromising the underlying decarbonisation methodology.

Figure 5: Simulated historical performance of two decarbonisation portfolios

Problems loading this infographic? - Please click here

Figure 6: Three- year change in carbon emissions

Problems loading this infographic? - Please click here

Source: S&P Trucost Limited © Trucost 2025.

Figure 7: Decarbonisation outcomes and forward-looking metrics⁶

Problems loading this infographic? - Please click here

SBTi Score is a weighted metric of the committed or approved short/long term targets of companies. The higher the score, the more credible the Net Zero targets are.

Source: Sustainalytics, MSCI,⁷ ©Carbon4Finance, 2025.⁸

Conclusion: The perfect recipe for real world decarbonisation outcomes

The transition to net-zero requires moving beyond carbon accounting exercises toward strategies that drive real-world emissions reductions. By systematically identifying companies with the greatest decarbonisation potential – including carbon-intensive transition leaders – investors may align portfolios with climate objectives while pursuing attractive returns.

1. IEA (2025), Global CO2 emissions from energy combustion and industrial processes and their annual change, 1900-2023, IEA, Paris https://www.iea.org/data-and-statistics/charts/global-co2-emissions-from-energy-combustion-and-industrial-processes-and-their-annual-change-1900-2023 , Licence: CC BY 4.0
2. https://www.man.com/insights/climate-allocation-compass
3. Net Zero Investment Framework 2.0 Report, IIGCC, 2025
4. Hartzmark, Samuel M. and Shue, Kelly, Counterproductive Sustainable Investing: The Impact Elasticity of Brown and Green Firms (November 1, 2022). Available at SSRN: https://ssrn.com/abstract=4359282 or http://dx.doi.org/10.2139/ssrn.4359282
5. Reproduction of any information, data or material, including ratings (“Content”) in any form is prohibited except with the prior written permission of the relevant party. Such party, its affiliates and suppliers (“Content Providers”) do not guarantee the accuracy, adequacy, completeness, timeliness or availability of any Content and are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, or for the results obtained from the use of such Content. In no event shall Content Providers be liable for any damages, costs, expenses, legal fees, or losses (including lost income or lost profit and opportunity costs) in connection with any use of the Content. A reference to a particular investment or security, a rating or any observation concerning an investment that is part of the Content is not a recommendation to buy, sell or hold such investment or security, does not address the suitability of an investment or security and should not be relied on as investment advice. Credit ratings are statements of opinions and are not statements of fact.
6. 2025 Sustainalytics. All Rights Reserved. The information, data, analyses and opinions contained herein: (1) includes the proprietary information of Sustainalytics and/or its content providers; (2) may not be copied or redistributed except as specifically authorized; (3) do not constitute investment advice nor an endorsement of any product or project; (4) are provided solely for informational purposes; and (5) are not warranted to be complete, accurate or timely. Neither Sustainalytics nor its content providers are responsible for any trading decisions, damages or other losses related to it or its use. The use of the data is subject to conditions available at https://www.sustainalytics.com/legal-disclaimers.
7. Certain information contained herein (the “Information”) is sourced from/copyright of MSCI Inc., MSCI ESG Research LLC, or their affiliates (“MSCI”), or information providers (together the “MSCI Parties”) and may have been used to calculate scores, signals, or other indicators. The Information is for internal use only and may not be reproduced or disseminated in whole or part without prior written permission. The Information may not be used for, nor does it constitute, an offer to buy or sell, or a promotion or recommendation of, any security, financial instrument or product, trading strategy, or index, nor should it be taken as an indication or guarantee of any future performance. Some funds may be based on or linked to MSCI indexes, and MSCI may be compensated based on the fund’s assets under management or other measures. MSCI has established an information barrier between index research and certain Information. None of the Information in and of itself can be used to determine which securities to buy or sell or when to buy or sell them. The Information is provided “as is” and the user assumes the entire risk of any use it may make or permit to be made of the Information. No MSCI Party warrants or guarantees the originality, accuracy and/or completeness of the Information and each expressly disclaims all express or implied warranties. No MSCI Party shall have any liability for any errors or omissions in connection with any Information herein, or any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of the possibility of such damages.
8. This publication is based on data produced by Carbon4 Finance. The data must not be reproduced, used, modified or published in any way without the written consent of Carbon4 Finance. Such data is provided "as is" without any warranty, express or implied. In particular, nothing contained in this publication should be construed as a representation or warranty, express or implied, regarding the suitability of investing or including companies in universes and/or portfolios. In particular, nothing contained in this publication should be construed as a representation or warranty, express or implied, regarding the suitability of investing in or including companies in universes and/or portfolios. Carbon4 Finance shall not be liable for any errors or omissions or for any damages arising out of the use of this publication and/or the data in any manner whatsoever

Important Information

This material is for informational purposes only and does not constitute investment advice or an offer to sell or a solicitation of an offer to buy any security. Past performance is not indicative of future results. Investment strategies may not be suitable for all investors and involve risk, including possible loss of principal. Any forecasts, opinions, or investment strategies discussed herein are subject to change without notice and may not prove to be profitable or correct.