Scope 3 Emissions and Their Impact on Green Portfolios

Abstract

The aim of this paper is to study the performance of carbon-based portfolios when all emissions scopes are accounted for. We formalize low-carbon portfolio strategies by integrating a carbon intensity penalty to a constrained mean-variance optimization framework. To do so, we resort to direct and indirect emissions data, split between Scopes 1-2 and Scope 3. Our empirical results show that it is possible to cut emission intensities in half at least with virtually no loss in Sharpe ratio for reasonable levels of the carbon constraint. These results are valid across various choices of risk aversions, and irrespective of emissions data provider. For a sustainability-aware investor, these low-carbon portfolios are associated to a higher level of welfare compared to their traditional counterpart. We find that the corresponding allocations are shifted towards assets with higher returns while keeping the portfolio’s volatility unchanged. Overall, our results add to the literature contending that sustainable investing is not costly.

Keywords: Scope 3 emissions, portfolio optimization, sustainable finance

JEL Classification: G11, G15, Q59