Race against the benchmark to decarbonise portfolios

Favouring transition leaders in the race to net zero

Our TargetNetZero strategies favour transitioning companies that we expect will decarbonise faster than their sector peers due to their Paris-aligned ambition levels and credible decarbonisation strategies. We call them transitioners. While some companies have already made significant progress, most still face transformation in the years to come. By favouring these future leaders of the transition, we aim for our TargetNetZero (TNZ) portfolios to decarbonise faster than their respective benchmarks.

To identify transitioners, our sustainability research team forecasts future emission pathways by combining: 

• A company’s current emission trends 
• Its future commitments to decarbonise 
• LOIM’s in-house analytics to assess the credibility of decarbonisation plans. 
   

The strategy’s investment process aims to fulfil our conviction to decarbonise: the process is designed to minimise the impact of forecasting error by providing diversified exposure to transitioners. 

Read also: How can the net-zero theme add value for investors?

Evaluating actual portfolio decarbonisation

Over the past four years, have our TNZ portfolios actually decarbonised faster than their benchmarks? This key question for investors yields no easy answers and the method of measuring emissions change is key. 

For us, portfolio decarbonisation is not merely a simple change in total portfolio emissions over time because this figure is affected by a range of factors including the change in coverage of emissions data as well as portfolio rebalancing. 

In our view, ‘genuine’ decarbonisation is the change in portfolio emissions arising purely from the availability of new emissions data while all other factors remain constant. Estimating portfolio decarbonisation is complicated by the irregularity of carbon emissions data, which is often reported with a significant time lag. Additionally,  the largest part of emissions - scope 3 emissions - is only approximated  by companies or third parties whose estimation methodologies are not yet standardised. 

“In our view, ‘genuine’ decarbonisation is the change in portfolio emissions arising purely from the availability of new emissions data while all other factors remain constant”

To address these issues, Lombard Odier Investment Managers (LOIM) has invested significant resources to create an in-house research hub specialising in sustainability data. Our expertise includes:

• ‘Cleaning’ carbon emissions data received from companies or other data providers
• Dealing with outliers, methodology changes and any other factors impacting data quality.

We used this data to evaluate the decarbonisation of our strategies when we marked our three-year anniversary last year. We believe the data is of higher quality, yet we also acknowledge that this analysis is not entirely unbiased. Indeed, data processing tends to enforce trend patterns in a time series. As a result, portfolios built on altered emissions data will mechanically exhibit faster decarbonisation rates when they are measured using the same data.  

In our view, a better comparison is possible using raw emissions data and only using the necessary measures to avoid a so-called ‘look-ahead bias’¹. This is a challenging exercise since raw data tends to exhibit erratic behaviour, limiting our confidence in the estimates produced. Additionally, the period of study is relatively limited since emissions are disclosed on an annual basis. Nevertheless, we believe such analysis provides insight and share our study’s findings in the following sections.

Breaking down changes in portfolio emissions

We made several choices to set the parameters of our study. Firstly, we used only emissions data reported by the companies themselves. Although this inevitably narrowed the coverage and potentially led to underestimating of total portfolio emissions, using company-provided data had the advantage of enabling a more adequate year-on-year comparison of companies’ carbon emissions, which was our primary objective. Additionally, for every date, we used the latest emission figures available at the time, regardless of the reporting year, which may differ between companies.

The change in portfolio emissions is driven by portfolio decarbonisation as well as several other factors. To isolate the pure effect of decarbonisation, we measured it on a daily basis and then aggregated it over the entire period. For each date we computed the impact of the availability of new data² at this date on total portfolio emissions, keeping other variables unchanged. 

Read also: Cutting emissions: a tale of two targets from the steel and shipping industries

Changes in technology or product mix, as well as investments (including mergers and acquisitions) can drive variations in a company’s emissions. In our view, emissions changes due to investments or other extraneous factors should not be classified as decarbonisation. For instance, when a business is sold to another company, its emissions are not reduced but merely transferred. 

Therefore, when computing portfolio decarbonisation, we disregarded the changes in emissions arising in years when companies made significant investments or disinvestments. Specifically, for each company, we identified years where the net cash flow from investing was outside of the two standard-deviation bounds based on historical data³.  

Emissions changes in the benchmark

Figure 1 explains the change in emissions of the MSCI World Index since the launch of our TargetNetZero strategies in 2021. The largest contribution came from the increase in coverage as the majority of companies have started reporting their scope 3 emissions⁴ only recently. The change in portfolio emission was further impacted by the ‘valuation effect’.  Since we measured the total portfolio emissions by tonnes of CO₂ equivalent attributed to USD 1 million in investment, the increase in market valuation over the last four years mechanically reduced the volume of emissions attributed to the same nominal investment. 

FIG 1. Decomposition of absolute changes in GHG emissions of MSCI World Index (April 2021 –  March 2025)⁵

For example, emissions of Paris-aligned benchmarks that commit to certain year-to-year emission reduction will likely be strongly impacted by rebalancing. In our view, this reduction should not be confused with portfolio decarbonisation; our view is also consistent with the best practice standards set out in Understanding the Drivers of Investment Portfolio Decarbonisation by the Net-Zero Asset Owner Alliance. 

Decarbonisation is the impact of pure portfolio decarbonisation, which stems from the effect of the availability of new data while all other factors are unchanged. As evidenced by Figure 1, the change in total emissions is clearly a poor measure  of decarbonisation, as it has been driven mostly by the change in coverage and the valuation effect rather than genuine decarbonisation. 

Read also: Sustainability in the new Trump era

Delving into decarbonisation details

Did our portfolios decarbonise faster over the same period? To answer this question, we compared the decarbonisation rates of Global and Europe TNZ equity portfolios and their respective benchmarks. We computed the portfolio decarbonisation in percentage terms by aggregating daily decarbonisation rates over the full period⁶.    

Figure 2 shows that both strategies indeed decarbonised at a faster rate since their inception. While this observation is very reassuring, we must note that it is still too early to draw definite conclusions. Reporting standards, particularly for scope 3 emissions, are still evolving. As of April 2025, only about half of companies in the MSCI World Index report their scope 3 emissions.  

FIG 2. Portfolio decarbonisation of TargetNetZero strategies (April 2021- March 2025)⁷

Measuring genuine portfolio decarbonisation is a complex task requiring deep analysis to filter the data and ensure accurate results. We believe this study illustrates that our  forward-looking approach ensures that TargetNetZero strategies decarbonise faster than their benchmarks.