Net-Zero Investing

Net-zero portfolios (NZPs) aim to reduce their carbon footprint over time, typically until 2050, by mimicking scientific paths of decarbonization, and aggregate carbon budget, for the global economy. Their popularity among institutional investors has been growing over time, with more than $100 trillion of global assets under management currently covered by various net-zero (NZ) investing initiatives. The first part of the chapter provides a discussion of the construct of the NZP, its benefits, and its potential limitations for portfolio managers. The second part of the chapter outlines the role of the NZP in asset prices. The channels underlying the pricing are divestment and engagement. Contrary to common wisdom that focuses on divestment that is already happening, being associated with an NZP initiative does not necessarily imply that investors need to divest from high-emitting companies right away. It may also mean an expectation of such divestment in the future. Because the expectation of divestment allows for a dialogue between institutional investors and corporates, the framework is also a form of engagement.Net-zero portfolios (NZPs) aim to reduce their exposure to carbon foot-print over time, typically until 2050, by mimicking scientific paths of decarbonization for the global economy. Even though NZPs by themselves do not guarantee the decarbonization of the global economy, they aim to provide incentives for companies to do so. Companies that undertake emissions reduction are rewarded by being included in NZPs, and companies that are behind the decarbonization curve are penalized by being excluded from NZPs. The popularity of net-zero investing among institutional investors has been rapidly growing, with more than $100 trillion of global assets under management currently covered by various net-zero investment initiatives. The NZP initiative has also shaped discussions surrounding sustainable finance, as is the case for the EU Low-Carbon Benchmark Regulation, which establishes uniform rules for low-carbon investment benchmark indexes and sets their required decarbonization trajectories.In this chapter, I first provide details that govern the construction of NZPs, building on the early work of Bolton et al. (2022). Next, I discuss the properties of such portfolios relative to a standard market portfolio benchmark. Finally, I discuss how the NZP framework can be applied to construct measures of carbon transition risk at the firm level, which offer conceptual improvements over measures in prior work by Bolton and Kacperczyk (2023).