Your recent article Carbon efficient firms outperform highlighted a recent working paper that found that carbon-efficient firms outperform their carbon-inefficient peers. As the working paper in question directly references the work of Engaged Tracking (ET), we felt compelled to respond.
In order to maintain our credibility as a responsible investment community, we believe that there are three key points to discuss in regards to carbon-efficient performance: Scope 3, robustness, and disclosure quality.
The indirect, value chain emissions that are captured in Scope 3 data are often actually the main source of carbon exposure for companies compared to more direct Scope 1+2 emissions. Engaged Tracking is a big proponent of our members using Scope 3 information in their investment strategies. In fact, our studies were the first to construct an Efficient-Minus-Intensive portfolio, and we continue to find that a global large cap portfolio based on Scope 1+2+3 has the best risk-adjusted performance (1.7% per year for the last 7 years, with an information ratio of 1.24 versus 0.63 and 1.17 for just Scope 1+2 and just Scope 3, respectively). This demonstrates that the information contained in each scope of emissions is different and complementary, and that combining these metrics together adds the most value.
Whether you look at ET’s factsheets, or MSCI’s, or Goldman Sachs’, they corroborate what we already know: that low carbon stocks have been outperforming for the majority of this decade. This fact gives momentum to the intuitive idea that more efficient firms generate better returns.Many investors are beginning to act accordingly. We should continue to trumpet low carbon performance to the world in a robust, credible way. It is important that we clearly describe methodologies and make robust adjustments, such as for serial correlation and heteroskedasticity in returns. And to be precise and open about the relatively nascent nature of our datasets.
Global improvement in greenhouse gas emissions disclosure quality means that real value can now be gleaned from the informed use of this data. In the past, investment organisations would typically construct their own estimate of a company’s emissions based on Bloomberg or Factset revenue data. Today, by carefully using reported data (and the lack thereof from laggard companies) we can add value by adding real information to the market. And this information offers a way to make a robust case for low carbon investment, in spite of the limited length of the industry’s data, by linking disclosed emissions data to long-term return anomalies that have been proven to exist in longer, more traditional datasets. These alpha-generating anomalies have been demonstrated and yet remain underutilised by the majority of investors.
We are delighted that Responsible Investor has brought attention to the topic of low carbon strategies. It is our collective responsibility to increase the intelligent flow of capital to companies and activities that are actively working towards a more efficient economy. The scale of the climate problem requires flows in the trillions of dollars. We can support these flows by demanding consistent, standardised emissions disclosure from all our portfolio companies.
James Cameron and Jonathan Harris are respectively Chairman and Chief Analyst at Engaged Tracking.