Iain Campbell: The challenge of measuring carbon emissions

Responsible Investing (RI) is an increasingly prominent area for the LGPS.  Pressure has been gradually mounting on funds, including numerous Freedom of Information requests and lobbying outside offices.

The RI issue with most public interest currently is climate change – a topic that spans both sides of the well-debated “morals versus returns” challenge. Whilst there are many who would argue against investing in the largest contributors to climate change based on non-financial, moral standpoints, financially-driven arguments are increasingly joining the debate.

“Low carbon” investing has been the most sought after solution to this issue; however there are a number of ways to implement this. Perhaps the best-tested approach has been through infrastructure investments aimed at renewable energy. The investment industry has also reacted to the demand and an increasing number of alternative options have become available and gained traction. Importantly, low carbon investments are no longer regarded as niche or specialist strategies.

Whilst low carbon investing has been around in equity investing for quite some time now, there has been a proliferation of products and solutions, (with increasing sophistication), particularly in passively-managed products. However, this increase in options brings with it an increasing dependency on investors taking views as to how they wish to tackle this issue.

A common starting point has been to measure the “carbon footprint” of a portfolio; though these are often backward looking and may not take into account the future plans of a business to improve their carbon efficiency.  These metrics are best used as a measure of progress over time towards any stated decarbonisation goals an investor may have. 

A potentially more helpful approach would be to measure the portfolio’s investments for future developments in relation to carbon emissions. This allows an investor to test their portfolio’s alignment with their aims, and can therefore form a part of investment decision-making. Within low carbon equity and bond indexing, the market has progressed from simple negative screening of the worst-emitting companies, and more intelligent ways of investing are now available. These include more positive approaches, such as investing in companies more aligned with a move to a greener economy. This may be measured by metrics such as revenue generated from particular operations that reduce carbon emissions.

A trend appearing within the low carbon space has been to combine this approach with factor based investing.  This can add a more widely accepted return-oriented aspect to a low carbon strategy, offering greater support against any concerns of potentially reducing returns. A number of LGPS funds and other large corporate pension schemes have commissioned indices and investment funds of their own to meet their lower carbon targets, some of which are open to investment from wider investors.

This year’s actuarial valuation is an ideal opportunity to consider the wider risks facing funds, including those posed by RI and specifically climate change, with an aim of determining how the investment strategy may be used to tackle such issues.  Mercer’s recent report “Investing in a time of Climate Change – the Sequel” provides more food for thought on this important issue.

Iain Campbell is an investment consultant at Mercer.