Climate risk pricing

Carbon negative leveraged investment strategies

Written by Ulf Erlandsson & Nona Alexander

This paper demonstrates how to apply and account for leverage and short positions in the context of carbon foot-printing and climate impact. Our analysis suggests ample opportunities for traditional fixed income portfolios to add long-short overlays in order to reduce or even negate their core position’s carbon footprint.

This paper illustrates how the usage of long-short strategies can contribute to reducing or even reach carbon neutral or negative footprint of an investment portfolio. The amount of leverage applied to such strategies will be crucial for the total impact. In the empirical section, we show how this could be feasibly applied in a credit derivative context, that should be suitable in particular for real-money investors that are able to use gross if not net-leverage on their core portfolios.

We believe a broader point of the paper is how it demonstrates the principle that the investments investors make in terms of “green” or less carbon-intensive assets on the long side are highly dependent on what they divested from or shorted on the other side to fund that investment. An investor buying a mediocre green bond can consider that investment as ’green-er’ if it is paired with shorting a high-fossil asset on the other side, whereas the investor shifting from a low-carbon benchmark into that mediocre green bond provides very little additionality from an investment impact perspective.

Link to article at SSRN

About the authors

Ulf Erlandsson

Ulf Erlandsson

Founder, Board member

Dr Ulf Erlandsson founded the Anthropocene Fixed Income Institute and was its first CEO. A pioneer of climate-focused fixed income portfolio management, he was named Environmental Finance’s Bond Personality of the Year 2022.

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