Investors should look at the entire picture when considering carbon emissions in asset decisions
By Dr. Dinah A. Koehler
The investment industry has begun to incorporate carbon emissions data into asset decisions, but investors who focus on simple solutions such as divestment or footprinting without considering other important factors may end up divesting companies that are successfully transitioning to lower carbon exposure. To build carbon-aware portfolios, consider carbon emissions while leveraging additional data, such as in-depth assessments of mitigation activities and progress toward a carbon reduction goal.
First-generation carbon-aware: Footprinting
Any conversation managing carbon exposure must start with data on corporate greenhouse gas emissions. Commercial providers of this data rely on voluntary corporate disclosure of carbon emissions, but less than half of these corporate disclosures are third-party reviewed, let alone audited. Providers make estimates for companies that do not report, which can lead to significant differences between provider data. Some investors use the data to report on the carbon emissions associated with stocks in a portfolio at a point in time—commonly called “carbon footprinting.”
Moving beyond footprints to glidepaths
While footprinting is useful for comparisons, carbon-aware investment should capture how companies and entire industries can contribute to the goal of limiting global warming to 2°C by 2100. The International Energy Agency has modeled what it will take to achieve the 2°C scenario, or 2DS. The 2DS provides guidance on the rate of change needed to reduce carbon emissions (see Exhibit 1) and focuses on those industry sectors that emit the most carbon (see Exhibit 2). The 2DS can be thought of as the optimal “carbon glidepath" to meet the goal.
Glidepaths offer a framework for rewarding overachievers and punishing underachievers by helping investors evaluate whether or not a company is likely to stay aligned with its carbon glidepath. Because carbon emissions are so highly concentrated in a few industry sectors, optimizing solely on carbon emissions can quickly change the portfolio’s characteristics. A better way to incorporate carbon into portfolio (or carbon-aware index) construction is to take into account all material portfolio factors along with active risk. It is possible to significantly reduce carbon emissions by 50 percent in alignment with the IEA 2DS carbon glidepaths, while maintaining a low active risk of about 30 bps.
Carbon as an investment theme
Financial products that effectively incorporate carbon data into investment decisions can meaningfully contribute to “decarbonizing” entire economies. Investment teams that understand the relevance and nuances of carbon data can provide solutions that deliver financial returns and meaningfully reduce carbon emissions and climate risks.
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This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular investment, strategy, investment manager or account arrangement.
Dr. Dinah Koehler is head of research for the Sustainable Equities team of UBS Asset Management. One of her roles is to develop partnerships with academic institutions to create UBS' Global Sustainable Impact Equity methodology. Koehler joined UBS Asset Management in 2015. Previously she advised and worked for large global corporations, national governments and international organizations on sustainability issues. She holds a science doctorate from Harvard University.