A large Asset Owner (AO) with USD 100+ billion AUM was concerned about how climate change could impact its equities portfolio. It considers itself a leader in the field of Environment, Social and Governance (ESG) policy, but climate change was not yet well incorporated into its policies. It therefore wanted to learn about best practices of peer AOs and commissioned Climate Risk Services to perform a benchmarking study.

A concern of every AO is that its portfolio contains risk that they do not know and for which they are not compensated. One major question of the AO was whether its peer group measures the CO2 intensity of its equities. Management thinker Peter Drucker once said that “you can’t manage what you can’t measure.”

Our study showed that almost all leading AOs calculate the carbon footprint of their equity portfolio; about half also calculate the footprint of their fixed income portfolio. Furthermore, about 2/3 of AOs take steps to decarbonise their portfolio. Some AOs tilt away from carbon, others exclude certain sectors (such as coal), while several are constructing climate based smart beta investment strategies.

But carbon intensity of portfolio’s is only part of the climate risk story. A portfolio with high carbon intensity may be subject to more regulatory risk as governments start pricing carbon emissions. The recommendations of the Task Force on Climate-related Financial Disclosures (TCFD)  encourages companies to assess and report on other types of climate risk as well, such as physical risk, technology risk, and the risk that social attitudes may change leading to forced divestiture of assets. As more climate data becomes available, a more bottom-up approach to assess climate risk will become possible.

Response
The AO is now working with one of its largest investment managers to decarbonise part of its passive equity portfolio. Its goal is to reduce the carbon intensity of the portfolio while keeping the tracking error to a minimum. Examples at other AOs show that this is indeed feasible. It is also integrating climate risk in its due diligence of tangible real asset investments.