investment viewpoints

    How best to measure portfolio decarbonisation?

    How best to measure portfolio decarbonisation?
    Thomas Höhne-Sparborth, PhD - Head of Sustainability Research

    Thomas Höhne-Sparborth, PhD

    Head of Sustainability Research
    Dominic Tighe - Senior Sustainability Analyst

    Dominic Tighe

    Senior Sustainability Analyst

     

    Need to know

    • There is no common framework for asset managers to measure decarbonisation in their portfolios and wide discrepancies exist in how climate-aligned assets are selected, managed and reported on.
    • We explore several possible approaches proposed by the Paris Aligned Investment Initiative (PAII) and believe the ‘custom’ benchmark approach best incentivises investing in the net-zero transition.
    • Our Implied Temperature Rise (ITR) tool combines custom benchmarks with forward-looking transition pathways to assess if companies are aligned with the goals of the Paris Agreement.

     

    The goal of net-zero carbon emissions is clear, but the path to get there is far less tangible for investors. There is no common framework for asset managers to measure decarbonisation in their portfolios, and there are wide discrepancies in how climate-aligned assets are selected, managed and reported on.

     

    Approaches to decarbonisation

    The Paris Aligned Investment Initiative (PAII) has outlined several approaches for tracking portfolio decarbonisation. Which approach to use is currently at the discretion of the asset manager.

    The ‘self-decarbonisation’ approach involves measuring portfolio emission intensity relative to a baseline year. Another approach involves measuring portfolio emission intensity against a standard benchmark, like the MSCI World. Both of these approaches are easy to implement and to communicate to stakeholders. However, they are likely to incentivise the wrong behaviour, in our opinion, prompting investors to achieve emissions reductions through re-allocating capital to low-carbon sectors while ignoring transition leaders in high carbon sectors that need sustained financial backing.

    Only the last approach – using ‘custom benchmarks’ - incentivises investing in the transition. Custom benchmarks establish what would be ‘typical’ performance for a fund, given the exact mix of industries and geographies it is invested in. For a fund just containing steel companies, this means a custom benchmark would compare the performance of the fund to that of the wider steel industry, rather than the economy as a whole. This provides a more accurate and relevant reference point than standard benchmarks.

     

    Aligning to net-zero

    At Lombard Odier, we combine custom benchmarks with forward-looking transition pathways consistent with different warming outcomes in our Implied Temperature Rise tool. This tool allows us to derive warming scores by comparing the emissions trajectories that companies and portfolios are on against the paths they must take in order to meet the goals of Paris Agreement.

    To us, real decarbonisation should be about investing in companies that are contributing to the greatest reductions in emissions, rather than focusing on low-carbon sectors, where less decarbonisation is occurring. High-emitting companies on credible reduction trajectories are often neglected, but they offer long-term value opportunities, as the world transitions towards net zero.

     

    The full report is available for download by clicking on the download button.

     

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