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You are here: Home / Investment News / Carbon fever: metrics matter as transition takes hold

Carbon fever: metrics matter as transition takes hold

February 21, 2021

Emily Steinbarth: Russell Investments quant analyst

Russell Investments NZ has published a new research paper on the fundamental measures underpinning the emerging science (or art) of investment decarbonisation.

Amid an explosion of low-carbon investment solutions as a proxy to manage climate change-related portfolio risks and opportunities, investors need to learn more about the various underlying metrics used in different strategies, the Russell study says.

“Before developing and managing an investment strategy incorporating carbon exposure, it is crucial that investors understand carbon metrics – that is, how carbon exposures are measured and calculated,” the paper says. “Understanding the metrics used to manage portfolio carbon exposure allows an investor to better understand the channels of transition risk and make better evaluations of whether they believe securities are fairly priced. Furthermore, values-motivated investors may prefer some metrics over others due to subtle differences in their meaning.”

The Russell report delves into the two basic climate change data fields carbon-sensitive investors rely on, namely greenhouse gas emissions (GHG) and fossil fuel reserves.

For example, GHG exposure is usually based on ‘scope 1 to 3’ emissions, representing an ever-widening spread of activities related to the company in question.

But GHG measures becoming increasingly complex as investors incorporate the data into real decision-making with several options available, including using ‘absolute’ or ‘standardised’ figures or taking the ‘portfolio-weighted’ or ‘ownership-weighted’ approaches.

Now emerging as the global standard-setter on carbon reporting etc, the Task Force on Climate-related Financial Disclosures (TCFD) tackles the problem from many angles.

“The portfolio-weighted approach is used by the TCFD when calculating weighted average carbon intensity (WACI),” the Russell study says. “Ownership-weights are used by the TCFD to calculate the portfolio metrics defined as ‘total carbon emissions’, ‘carbon footprint’, or ‘carbon intensity’.”

Russell says its “first-choice metric” is the WACI, which offers the benefits of relatively simple calculation and popularity among investors and index providers.

“Specifically, we prefer the calculation of carbon exposure through revenue standardisation and portfolio weights. Russell Investments uses the WACI metric to calculate the carbon exposure of its Low Carbon Global Shares fund,” the paper says. “However, it would be an overstatement to say there is a clear consensus on the use of WACI; the alternatives… are all viable options that suit different purposes.”

Investors also have several choices in estimating fossil fuel reserves in their portfolios, Russell says.

The study takes in a further range of considerations for climate-conscious investors including non-corporate securities (such as government bonds), scenario-analysis, other environmental measures, exposure to ‘high stakes’ sectors and impact investing.

On the positive side of the ledger, investors could also look for climate-related opportunities.

“From a ‘value’ perspective, carbon exposures are a proxy for an investment’s exposure to transition risk, while climate-related opportunities measure the same factor albeit in the opposite direction,” the report says. “From a ‘values’ perspective, exposure to climate-opportunities may fit with an investor’s desire to be involved in the low-carbon transition. Because climate-related opportunities are broad in definition, there is no consensus on a universal set of metrics that should be used for measurement and comparison.”

Investors are still grappling with inconsistencies among underlying carbon data suppliers and reporting standards, according to the study written by Russell NZ senior analyst, Mihir Tirodkar, and US-based senior quantitative research analyst, Emily Steinbarth.

In spite of the rising pile of carbon jargon and incomplete datasets, the report says “if investors are worried about the exposure of their portfolio to climate transition risks or want to match their investments with their values, understanding carbon metrics and their nuances is a crucial first step”.

Under legislation introduced last year, NZ will be the first in the world to mandate climate risk reporting for entities across the financial sector including corporates, fund managers and others. The NZ climate reporting regime will take force by 2023 at the earliest, the Russell paper says.

Highlighting the push for carbon-lite and climate change-linked investment strategies a couple of other global institutions also weighed into the issue last week.

Credit Suisse outlined its climate change strategy in ‘The decarbonizing portfolio’ report.

“Our goal going forward is to continue to expand our investment suite to provide our clients with an increasingly larger diversified set of options to decarbonize their portfolio, in line with our motto, ‘Generate returns. Sustainably’,” Credit Suisse says.

At the same time, French investment powerhouse Amundi released its 2020 proxy voting record and push companies harder on climate change factors this year.

“… in addition to the necessary measurement of the carbon dioxide emissions trajectories of the companies in which we invest, Amundi will support resolutions calling for greater transparency on emissions reduction strategies, combined with specific targets,” a statement says. “Similarly, we would like an increasing number of companies to make commitments to reduce their emissions in line with scientific objectives: the adoption of targets as part of the ‘Science Based Target’ initiative (SBTi) will therefore be one of our main themes of engagement in 2021.”

 

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