Do Investors Care About Offsetting Carbon Risk?

Understanding the financial impact of climate change is critical for investors and portfolio managers as carbon transition risk increasingly shapes global markets. This article provides empirical evidence that investors price carbon emissions as a material risk, demanding a higher transition risk premium for firms with substantial Scope 1 and Scope 2 emissions. Regulatory pressures, shifting investor sentiment, and energy transition drive this premium, with proactive climate policies and higher renewable adoption reducing risk, while weak regulations and fossil fuel dependence amplify it. The authors find that carbon offset inventory can help mitigate this premium, as firms located in regions with higher offset inventory tend to experience reduced transition risk. For practitioners, these findings offer actionable insights into managing climate-related risks in portfolios. Asset managers should include carbon transition risks, emissions, regulations, and offset exposure in portfolios. As climate risks are priced into markets, understanding these factors is key to building resilient portfolios and optimizing returns.