The TEXPERS Blog

There are multiple factors to consider when incorporating carbon emissions data into investment decisions

By Dinah A. Koehler

Guest Columnist

The investment industry has begun to incorporate carbon emissions data into investment 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. The UBS Sustainable Investors team believes that the best approach to building carbon-aware portfolios is to 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 (GHG) 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 degrees Celsius by 2100. The International Energy Agency (IEA) has modeled what it will take to achieve the 2 degrees Celsius scenario (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 a portfolio (or carbon-aware index) construction is to take into account all material portfolio factors along with active risk. We believe 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.

(This is a summary of a longer report by Koehler. Visit www.ubs.com/am to access the full paper.)

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of UBS Asset or TEXPERS.

Dinah A. Koehler

About the Author:

Dinah Koehler is executive director, sustainable investment research. One of her roles is to develop partnerships with academic institutions to create our 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.