The ‘fake’ alpha derived from low carbon strategies

Using low carbon strategies reduces portfolio performance and can lead to problems with concentration and investability, according to Scientific Beta. 

The research organisation said investors were mistakenly using low carbon strategies as a way to add alpha to their performance.  

In its research paper, When Greenness is Mistaken for Alpha: Pitfalls in Constructing Low Carbon Equity Portfolios, it said using low carbon could also add higher costs. 

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“Constructing portfolios using low carbon scores like any other alpha score does not improve performance and leads to problems with concentration and investability,” it said. 
 
“The costs borne by investors who build portfolios with a mistaken belief in a positive low carbon alpha are substantial. Multi-factor portfolios that impose positive weights on the low carbon factor have an inferior risk-return profile: A low carbon allocation of 40% leads to a poorly factor-diversified portfolio and as a direct consequence gives up 100bp of annualised returns on a risk-adjusted basis.”  
 
If investors were set on using these type of strategies, the firm said, it should consider how much the strategy would help them hedge climate risks or make a positive impact on corporate behaviour.  

Dr Noel Amenc, chief executive of Scientific Beta, said: “The pressing issue faced by society is tackling climate change, not generating alpha. And while low carbon alpha appears to be fake, the damage from climate change unfortunately is real”.




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