How are institutional investors tackling climate-change risk in their portfolios? Thanks partly to global initiatives such as the Montreal Pledge1 and the Portfolio Decarbonization Coalition,2 both launched in 2014, many institutional investors have moved quickly to understand the long-term portfolio implications of climate change and to adopt climate-risk management techniques. How have these commitments been reflected in their practices?
In our recent consultation with global institutional investors, we found that the state of the art has advanced very rapidly.3 While carbon footprinting (basically, measuring and disclosing exposures to carbon risk) across asset classes was a priority for most institutional investors we consulted, we also observed a growing demand for integration of climate transition risk in portfolios.
Institutional investor priorities for managing carbon risk across asset classes
Data as of November 2016 – January 2017
Equities. Much of the initial focus was on equities. As of June 2016, listed equities represented 96% of carbon-footprint disclosures by Montreal Pledge signatories, and bonds less than 15%.4
Investors initially focused on carbon footprinting, which led some to screening, divestment and allocation to funds that replicate low-carbon indexes. Now, a growing number are moving to assess “transition risk” posed to carbon-intensive assets by increased regulatory and non-regulatory drivers.5
However, there are important regional distinctions. While European institutional investors generally showed more interest in carbon risk and management strategies, U.S. institutions preferred decarbonization/screening. Dissimilar U.S. and European regulatory regimes could explain the difference, though there is no favored approach even within Europe.
Fixed income. Institutional investors in our survey showed increased interest in carbon footprinting for their fixed-income portfolios, but this was limited largely to corporate bonds and there was no consensus on how to implement it.
More than 85% of all respondents were inclined toward a “risk-exposure approach,” which uses a weighted average carbon intensity (WACI)6 metric; more than half expressed a clear preference for it.
Some 47% were inclined toward a “financed-emissions” approach, though only 12% showed a clear preference for this approach.
For multi-asset class portfolios with exposure to sovereign issuers, nearly four out of five institutional investors preferred separate reporting for sovereign and non-sovereign issuers.
Despite these differences, our study found growing demand among global institutional investors for consistent and comparable assessments of climate-change risk and opportunities across portfolios, which suggests the need for greater standardization of underlying methodologies and data.
1 http://montrealpledge.org/; http://unepfi.org/pdc/
2 Source: MSCI ESG Research, Carbon Footprinting 101: A Practical Guide to Understanding and Applying Carbon Metrics (September 2015).
3 MSCI ESG Research LLC consulted with 25 institutional investors during November 2016 - January 2017 to gain insight on the current status and identify future trends of climate change risk management among them.
4 Montreal Carbon Pledge: Accelerating Investor Climate Disclosure. https://www.unpri.org/download_report/22480
5 Source: MSCI ESG Research, Regulatory Easing: Potential Impact on Energy Sector (May 2017)
6 This metric measures a portfolio’s exposure to carbon-intensive issuers. It is computed by first calculating the carbon intensity for each portfolio constituent and then calculating the weighted average by portfolio weight.
Further reading:
The State of Climate Change Risk Management by Institutional Investors
The State of Climate Change Risk Management by Institutional Investors (Access to ESG clients only)
Fossil Fuel Divestment: How Wide a Net to Cast?