The right way to carbon monitor your scheme

Members now typically expect a high degree of transparency regarding investment decisions being made on their behalf, including their schemes’ exposure to companies and sectors with a high carbon footprint – a catch-all term covering CO2 and various other greenhouse gas emissions.

Unfortunately, measuring this footprint is impossible to do entirely accurately. The various methods for carbon monitoring a diversified investment portfolio spanning mainstream and alternative asset classes are very much a work in progress.

It makes sense to begin carbon monitoring with asset classes where information quality is good

Despite some excellent tools and data sources, there is no off-the-shelf, all-encompassing solution. Pension schemes are therefore well advised to set realistic objectives, take a step-by-step approach and not go it alone.

Set goals for your scheme

There is little point in gathering data purely for the sake of it. What is the ultimate goal? This is where individual schemes will have their own priorities, both in terms of member expectations and long-term investment strategy.

One approach is to use the carbon data to minimise the portfolio’s current impact on climate change through the divestment of the worst culprits. This can be combined with more positive, forward-looking steps, such as engaging with companies and directing investment towards renewable energy and other low-impact technologies. 

Many schemes will be guided by high-level targets such as the 2C limit agreed at the recent United Nations Framework Convention on Climate Change – Paris Conference.

There are also purely pragmatic reasons for monitoring and decarbonising pension schemes’ portfolios. For instance, fiduciary-responsible scheme managers will aim to steer away from the so-called stranded assets represented by fossil fuel reserves that cannot be used within the Paris agreement constraints. This might mean foregoing short-term gains.

Such risk mitigation can be combined with a more return-seeking strategy based on investing in the future low-carbon economy.

Take a step-by-step approach

Pension scheme managers looking at carbon monitoring and reduction for the first time may wish to consider switching parts of their portfolio to low-carbon indices as a first step.

This effectively outsources the job of reducing the carbon footprint of the standard equivalent index by weeding out the worst greenhouse gas emitters and holders of fossil fuel reserves.

While larger-cap companies in developed markets have generally improved their carbon reporting, there are many areas of the market where accurate information is hard to get. 

In emerging markets, the problem is compounded by a combination of particularly high carbon emissions and inadequate data.

There are also major difficulties in accurately evaluating unlisted firms, smaller companies and many alternative investments. Accurate carbon footprints can only be measured by including upstream and downstream direct and indirect emissions.

While work continues on improving data reliability in other parts of the market, it makes sense to begin carbon monitoring with asset classes where information quality is good.

Join a club

Faced with these difficulties, groups of like-minded industry players have decided to combine their efforts to apply pressure where it is most needed, as well as working on consistent methodologies and standardised reporting formats.

One such group is the Portfolio Decarbonisation Coalition that was set up by Sweden’s AP4, the Carbon Disclosure Project, asset manager Amundi and the UN Environment Programme Finance Initiative in 2014.

It combines asset owners and managers from Europe, North America and Australia, ranging in size from around $25m (£20m) to well over $1tn (£805m) in assets under management.

Interestingly, members’ influence and contribution do not appear to be linked to size. Some of the pioneers were smaller funds whose environmentally focused stakeholders put them at the leading edge of the portfolio decarbonisation movement. 

Their smaller size perhaps also meant they were prepared to take greater risks in trying to implement green investing across the whole portfolio.

Pension schemes looking to begin carbon monitoring can benefit from membership of or affiliation to one or more of these industry initiatives.

Richard Tyszkiewicz is a senior director at consultancy bfinance