The financial case for decarbonising investment portfolios

The Portfolio Decarbonization Coalition (PDC) recently released its second annual progress report: Investment Portfolios in a Carbon Constrained World
The report describes the actions being taken by PDC’s 27 signatories (representing over US$3,000 billion in assets under management) to decarbonize their investment portfolios. While the report cautions that decarbonization is a relatively new activity for many institutional investors, it does point to three encouraging findings. The first is that investors looking to track the major investment indices can achieve the same investment performance, with limited tracking error, but with significantly lower carbon footprints. For example, PDC signatories FRR, Amundi and AP4 have collaborated with MSCI to develop the MSCI Low Carbon Leaders indices. For the relevant investment universe, these indices exclude both the top 20% of companies based on carbon emissions intensity (i.e. Scope 1 and Scope 2 emissions per million Euros of turnover) and the largest owners of reserves per dollar of market capitalisation. The aim is to achieve at least a 50% reduction in carbon footprints relative to the relevant parent indices. FRR has reported that, since their introduction in Europe and North America at the end of 2014, these low carbon indices have outperformed the benchmark indices by 2% and 1.5% respectively.
The second is that PDC signatories agree that decarbonized portfolios offer potentially significant long-term investment benefits. They identify the benefits of decarbonization as including a reduced risk of value impairment because of climate change-related regulation, reduced risk of strandedassets and increased exposure to the companies that are likely to be the beneficiaries of the transition to a low carbon economy (e.g. in areas such as renewable energy).
The third is that there is clear evidence of ‘learning by doing’. PDC members have noted that many of the capacity and expertise barriers to progress tend to disappear as analysts and fund managers develop their understanding of how climate change is relevant to them and their activities. For example, Amundi, Hermes and Local Government Super have all commented that their investment teams’ increased familiarity with carbon data has led to analysts and fund managers pressing companies to provide better disclosures on these issues. In addition, Local Government Super has noted that, by working with companies and with its data providers, it is able to source better data on company emissions, thereby enabling it to make more informed investment decisions.
Despite these encouraging conclusions, it is clear that the overarching investment case for decarbonization needs further analysis. Many of PDC’s members have qualified their commitments to decarbonization by noting that they need to deliver investment performance or by arguing there needs to be a business case for action. These qualifications suggest that they are concerned about how decarbonization will affect their investment performance, and about whether the goals of carbon reductions and delivering investment performance can be reconciled. Work is, therefore, required to understand the relative merits of different decarbonization strategies, to develop a robust

understanding of the relationship between decarbonization and investment performance, and to understand the mechanisms and pathways whereby decarbonization strategies contribute to investment performance.
Developing the evidence base for decarbonisation is, clearly, a priority for PDC. But it should also be a priority for the wider investment industry.We therefore encourage asset owners and asset managers – irrespective of whether or not they are members of PDC – to analyse and report on their experiences with decarbonisation, on the investment performance outcomes they have achieved and to reflect on the factors that have driven this performance. With this commitment to analysis and information-sharing, we can build the investment case for decarbonisation.

Rory Sullivan is an independent consultant, specialising in the areas of responsible investment and climate change. Lisa Petrovic is the PDC Coordinator at the United Nations Environment Programme Finance Initiative. They are the authors of the second annual report of the PDC.