Net Zero ‘impossible’ for investors through long only portfolios, says AQR Capital’s head of RI

US fund’s Christoper Palazzolo believes volatility will be an obstacle to long-only decarbonisation efforts

Net Zero will be “impossible” for investors using long-only strategies, according to the head of responsible investing at US hedge fund giant AQR Capital Management.

Speaking yesterday on the topic of short selling and decarbonisation at the Sustainable Investment Forum North America 2021, the $137bn asset manager’s Principal and Head of Responsible Investment, Christopher Palazzolo, told delegates that “Net Zero is really just impossible today through a long only portfolio”.

Palazzolo said that the fund has been able to cut emissions by around 50% in its low-carbon, long only portfolios – through which it runs around $20bn – “with not too much difficulty”. But he added that it becomes “increasingly difficult” to meet investor demands for continual emission reductions beyond that point out towards Net Zero using long only approaches. 

Pointing to recent research by AQR, Palazzolo said that cutting emissions in a long only strategy beyond 50% “you quickly get to double digit additional volatility numbers versus a market portfolio or benchmark”. This level of volatility, he added, is simply “not tolerable for most investors”.

“I would say that emission cuts beyond 50% and long only is a tremendous challenge. Net Zero is really just impossible today,” Palazzolo said. 

The situation isn’t likely to change anytime soon either, according to Palazzolo, given the state of companies’ transition plans, many of which he said are not even targeting 50% emission cuts by 2035. 

A solution to this problem, Palazzolo ventured, is shorting, which “does wonders for climate hedging”. 

Shorting, he argued, can effectively allow investors to offset emissions. Palazzolo explained that when an investor buys a stock in a company “they’re indirectly supporting emissions [although not creating them], so the short investor does the opposite…the short investor is not directly removing carbon from the atmosphere, but just like a long investor is supporting emissions, a short investor is doing the opposite”.

Last month, AQR reportedly wrote to the Australian Prudential and Regulatory Authority, warning that its clients, including a number of super funds in the country, could start shorting polluting companies listed on the Australian stock exchange, the ASX.

Also on yesterday’s webinar was Rick Slocum, CIO at the Harvard Management Company, manager of Harvard University's endowment, who explained how shorting might allow investors with carbon budgets to hold and engage high emitting companies.

“If they want to engage, they'll need to go long like Engine No.1 did with Exxon, and they won't do it if their carbon budget is out of whack,” Slocum said. But “if you allow them to short other energy companies so that they can go long and engage with companies they in particular want to try to force change, then [that] can  be a very constructive use of shorting.”