Thought Leadership

A summary: carbon-transition risk and net-zero portfolios

As at 15 January 2024

Author: Gino Cenedese

Measuring transition risks

With more than $100 trillion of global assets now under a net zero, are decarbonisation efforts reflected in market pricing? Looking at ‘Distance to exit’ can be a useful tool in judging whether climate action is reflected in stock returns.

As the world moves to renewable energy sources, businesses face transition risks. Progression towards carbon neutrality brings considerable uncertainty. Climate policy can change quickly, and there are damaging reputational consequences for neglecting environment responsibilities. There may also be shifts in investor attitude and technological innovation. Understanding the extent of this transition risk, and its impact on investor returns, is vital in the construction of net zero portfolios.

Fulcrum has worked with Imperial College London to create a framework for measuring transition risk. This framework combines the scientific and social objective of decarbonising the economy with forward-looking elements of risk to understand its impact on asset pricing. It looks at the extent to which it is reflected in current valuations, and whether it affects sector diversification in portfolios.

Net-zero portfolios aim to reduce aggregate carbon emissions to zero by a specific date. They are becoming a popular vehicle, reflecting a growing desire among institutional and retail investor preference for investments that do not contribute to climate change. They are also an increasingly important part of global capital markets, with more than $100 trillion of global assets under management currently covered by various net-zero investment initiatives.¹

Net-zero portfolios combine two elements: an annual carbon budget based on independent scientific projections, and the investor’s methodology for selecting companies. As the carbon budget gets progressively tighter, companies failing to improve their carbon footprint are more likely to exit net zero portfolios. Investors should require compensation for bearing this higher transition risk.

Example of annual carbon budget of a hypothetical portfolio (in gigatonnes of CO2-equivalent).

Source: Fulcrum Asset Management

The Fulcrum research aims to reflect this progression, using a new method to measure the point at which companies are excluded from net zero portfolios. ‘Distance-to-exit’ (DTE) calculates the distance, in years, until a company is removed. DTE is a forward-looking measure of carbon-transition risk implied by investor preferences. In theory, companies with low ‘DTE’ scores should have lower valuation ratios and higher expected returns.

Pricing and decarbonisation

The research identified three direct channels through which the pricing effect could operate on a company’s share price. First, there may be divestment by a significant number of investors, who decide they no longer want to take the environmental risk on an individual company. Alternatively, investors may start to anticipate future divestment, which could impact the price. Finally, through net-zero portfolios and engagement programmes, investors could communicate their expectations of future divestment to corporates, and thus exert pressure on corporates to adjust their environmental behaviour. In this way, net zero portfolios can be a tool for both divestment and engagement.

In examining whether transition risk is captured by investment valuations, the research considered three ways in which investors may exclude companies from net-zero portfolios, an in turn determine DTEs: the first looked at companies’ total emissions. This assumes that the amount a company is emitting today can be a predictor of future decarbonisation efforts. It prioritises companies with lower total emissions and takes into account scope 1, 2 and 3 emissions, measuring direct emissions and those across a company’s supply chain.

Second, it looks at predicted total emissions. Decarbonisation inevitably takes time, so this approach assumes that what matters most is where companies are later on, not necessarily where they are today. It takes a weighted average of pre-announced, self-reported firm commitments to decarbonise and past emissions trends.

The third approach combines current and future emissions to give an ‘ambition score’. It aims to capture both a company’s intention and ability to decarbonise their future activities. To do so, it looks at historical emissions levels and their growth rates (50%), historical emissions intensities and their growth rates (25%), and forward-looking climate-related activity metrics (25%). This is the toughest measure of a company’s emissions.

Strong association

Across all specifications, the research showed a statistically strong negative association between DTE and stock returns. The results are economically large: a one-standard-deviation increase in DTE is associated with an approximate 2.5-4.6 percentage-point reduction in the next month’s annualised stock returns. While the predictive power of DTE declines over a longer time period, it remains significant, even looking out 12 months. These results support the hypothesis that companies with lower DTE are more risky and investors require higher compensation from them.

On three key measures of value, price-to-earnings, price-to-book, and price-to-sales, the research shows a strong positive correlation with DTE and lower valuations. These results suggest that decarbonisation is a differentiating factor for investors, leaving those companies with a weaker decarbonisation profile priced with lower multiples than those where there is less pressure. This shows transition risk is real. Equally, the correlation is stronger when the most comprehensive metric of decarbonisation is used – the ‘ambition’ score outlined above – and also when scope 3 emissions (regarded as more ‘noisy) are excluded.

Sector bias

There have been concerns that in targeting net zero, investors may introduce sector or thematic biases into a portfolio relative to their benchmark. This has been a particular concern more recently, with the war in Ukraine creating significant volatility in energy-related sectors, creating a gap in portfolios able to hold fossil fuel companies and those who could not. However, over the longer-term, our research suggests that it is possible to construct net-zero portfolios that have relatively limited expected tracking error, ranging between 0.08% in 2021 and 1.9% in 2050. Portfolio decarbonisation is feasible without losing diversification benefits. Over time, net zero portfolios do not create a strong tilt away from any individual industries.

So, are decarbonisation efforts reflected in market pricing?

The framework described in this summary paper can be applied to examine the carbon-transition risk implied by investors’ preferences. The DTE is significantly related to cross-sectional variation in stock returns and their valuation ratios. This is encouraging for investors in net zero portfolios, suggesting that markets increasingly value the decarbonisation efforts of companies, and may influence corporate behaviour by impacting corporates’ cost of capital.


Find the full research paper here.


About the Author

Gino Cenedese

Gino Cenedese is a Senior Economist in Fulcrum’s Research Team, where he conducts quantitative research with a focus on global multi-asset strategies and climate finance. Before joining Fulcrum, he was at the Bank of England, where he worked across the Monetary Analysis, Financial Stability, and International directorates. His research has been published in leading academic journals, including the Journal of Finance, the Journal of Financial Economics, and the Review of Finance. Gino holds a PhD in Finance from Warwick Business School.

This article was originally published in ESG Investor on 12 January 2023

1. See, for example,;; and The specific initiatives need not be mutually exclusive; hence the economic value of the movement measures its upper bound.


This content is provided for informational purposes and is directed at professional clients as defined in Directive 2011/61/EU (AIFMD) and Directive 2014/65/EU (MiFID II) Annex II Section I or Section II or an investor with an equivalent status as defined by your local jurisdiction.  Fulcrum Asset Management LLP (“Fulcrum”) does not produce independent Investment Research and any content disseminated is not prepared in accordance with legal requirements designed to promote the independence of investment research and as such should be deemed as marketing communications.  This document is also considered to be a minor non-monetary (‘MNMB’) benefit under Directive 2014/65/EU on Markets in Financial Instruments Directive (‘MiFID II’) which transposed into UK domestic law under the Financial Services and Markets Act 2000 (as amended). Fulcrum defines MNMBs as documentation relating to a financial instrument or an investment service which is generic in nature and may be simultaneously made available to any investment firm wishing to receive it or to the general public. The following information may have been disseminated in conferences, seminars and other training events on the benefits and features of a specific financial instrument or an investment service provided by Fulcrum.Any views and opinions expressed are for informational and/or similarly educational purposes only and are a reflection of the author’s best judgment, based upon information available at the time obtained from sources believed to be reliable and providing information in good faith, but no responsibility is accepted for any errors or omissions. Charts and graphs provided herein are for illustrative purposes only. The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. Some of the statements may be forward-looking statements or statements of future expectations based on the currently available information. Accordingly, such statements are subject to risks and uncertainties. For example, factors such as the development of macroeconomic conditions, future market conditions, unusual catastrophic loss events, changes in the capital markets and other circumstances may cause the actual events or results to be materially different from those anticipated by such statements. In no case whatsoever will Fulcrum be liable to anyone for any decision made or action taken in conjunction with the information and/or statements in this press release or for any related damages. Reproduction of this material in whole or in part is strictly prohibited without prior written permission of Fulcrum Copyright © Fulcrum Asset Management LLP 2024. All rights reserved.

FC372 040124

Share this article

Share on facebook
Share on twitter
Share on linkedin
Share on whatsapp
Share on email
Your privacy

Cookies are data files that are stored on your computer or other smart device by a website’s server. Each cookie is unique to your web browser. It will contain some anonymous information such as a unique identifier, website’s domain name, and some digits and numbers. Cookies are useful as they allow us to recognise a user’s device and its preferences in order to ensure that our website works properly. By continuing to use this website, you consent to the use of our cookies.


You can find out the different types of cookies used on our website in our Cookies and Data Privacy Policies.

Necessary cookies