Performance and Challenges of Net-Zero Strategies in the Context of the EU Regulation

This paper presents a comprehensive comparative analysis of various portfolio construction techniques in the context of decarbonization and the pursuit of net-zero objectives aligned with the 2015 Paris Agreement. Specifically, we examine different strategies that qualify as Article 9 funds under EU regulations, focusing on carbon emissions reduction objectives, such as screening and tracking error minimization techniques. Our findings indicate that all approaches would have achieved the targeted emissions reductions over the 10-year period (2012-2021) analyzed. However, the method of decarbonization significantly affects ex-post tracking errors, with the more ambitious Paris-Aligned Benchmark requiring a substantial departure from the business-as-usual benchmark. Additionally, the tracking error minimization approach involves considerable reallocation of individual securities, potentially leading to, possibly undesirable, idiosyncratic exposures.