What shade of green is your portfolio?

Key points:

• The potential effects of climate change are expected to create financial risks and opportunities for companies and investors
• Carbon footprinting has emerged as a method to help implement a portfolio strategy that can prepare for the transition to a low-carbon world
• The method shows investors their contribution to greenhouse gas emissions through their investments
• While climate crisis is a global and systemic challenge, it is with collective action that it can be overcome.

As climate breakdown speeds up and its physical effects intensify, so too do potential financial risks and opportunities for investors. At the moment, global plans do not deliver the commitment to keep temperatures within 2C of their pre-industrialised levels, let alone the 1.5C ambition, of the 2015 Paris Agreement.

Countries are scheduled to convene to review their progress and nationally determined contributions at the UN Climate Change Conference – COP26 next year. Given progress made so far, expanded efforts and pledges will be needed to achieve the targets.

As a low-carbon economy nears, investors may want to increasingly understand the potential physical impacts and transition risks for portfolios. Carbon footprinting has emerged as a useful tool in informing and implementing a portfolio strategy that can prepare for these challenges.

Greenhouse gas (GHG) emissions are embedded throughout business and society. Accounting for an activity’s carbon footprint can help to understand the climate risk and opportunities in an investor’s portfolio.

Carbon footprinting measures the impacts of an activity on global warming by calculating their GHG emissions. This is done to show greenhouse gases like carbon dioxide, methane and nitrous oxide as a common unit, allowing easier comparison in different geographies, industries and organisations.

Measuring the carbon footprint

Emissions Scopes are categorised by the GHG Protocol under three distinct categories, generally known as Scope 1, 2, and 3, which helps to systematically define different emission contributors. The categories allow for standardised emissions calculating and reporting, and a better understanding of emissions sources.

Most public companies report on the emissions from primary activities (captured by Scopes 1 and 2) and few reports incorporate disclosures about indirect emissions that occur in their value chain. However, Scope 3 emissions often represent a business’s most significant GHG contribution.

Understanding your footprint

For investors wanting to calculate their portfolio’s carbon footprint, the first step is to understand where emissions specifically come from. At its simplest, the carbon footprint is the sum of a proportional amount of each portfolio company’s emissions (proportional to the amount of stock held in the portfolio).

While there are several approaches to provide a carbon footprint measure, carbon intensity is commonly used and determines the amount of emissions, in tons of CO2, that the companies in the portfolio produce for every million dollars of sales.

These tools can be useful to consider not only carbon but also natural capital, fossil fuel reserves and exposure to stranded assets. Having a carbon footprint also lets investors compare their results to global benchmarks, identify priority areas for reducing emissions and track progress in making those reductions.

Understanding a portfolio’s footprint can serve as an informed starting point for an investor to create and implement a broader climate change strategy. It provides insight to identify a portfolio’s climate risk exposure to physical and transition risks. It should help consider allocation strategies for creating a lower-carbon portfolio and inform asset selection, while in addition the approach can support investors to find diversifying or growth opportunities in green investments.

Most importantly, carbon footprinting shows investors their contribution to GHG emissions through their investments. By understanding their current path and serving as a reference point on what their investment plans are, investors can address climate change on a personal level too. While climate crisis is a global and systemic challenge, it is with collective action that it can be overcome.

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