This report first distinguishes climate friendliness from carbon risk (Chapter 1). It then explores how investors can increase their climate friendliness by asset class (Chapter 2) and achieve a climate impact, defined as GHG emissions reductions in the real economy through positioning and signaling (Chapter 3). Finally, the report assesses the landscape of available metrics and their suitability for each strategy (Chapter 4) and concludes with a summary and possible future developments (Chapter 5).
Each chapter offers a list of do’s and don’ts to bring out key points. These lists provide a helpful summary of the report’s main findings and recommendations.
CHAPTER 1: DISTINGUISHING CLIMATE-RELATED OBJECTIVES
DON’T TRY TO KILL TWO BIRDS WITH ONE STONE
• Investor rhetoric on climate change references both carbon risk and climate friendliness. Investors can pursue one or both of the two objectives. Because some strategies do not achieve both objectives, investors may need to identify two parallel strategies. In their investment activities, positioning, and signaling, investors should be clear about whether they are following a carbon-risk-driven strategy, a climate-friendliness-driven strategy, or both.
DO CONNECT THE DOTS BETWEEN CARBON RISK AND CLIMATE FRIENDLINESS AT THE PORTFOLIO LEVEL
• Achieving a carbon-risk or climate-friendliness objective in a portfolio may require different approaches. Differences may be particularly pronounced when looking at financial assets, but may converge when assessing the two objectives from a portfolio or strategic asset allocation perspective.
CHAPTER 2: CLIMATE-FRIENDLY INVESTOR ACTIVITIES
DON’T FOCUS EXLUSIVELY ON LIQUID MARKETS
• Climate-friendly approaches in equity and bond portfolios often depend on reaching a critical mass of investors to achieve impact by limiting the cost or availability of capital. Investors should also consider less liquid assets to maximize impact.
DON’T IGNORE SECTOR DIVERSIFICATION
• Today’s mainstream benchmarks are poor guides to appropriate climate-friendly sector diversification. Investors should advocate for the development and use of climate-friendly indices that focus on climate solutions, exclude climate problems, or tilt allocations to high-performing companies.
DO ENGAGE
• For listed and private equity investors, engaging with companies should be coupled with portfolio construction activities. Impact via engagement activities can be more direct than portfolio construction.
DO FOCUS ON ENERGY TECHNOLOGY DIVERSIFICATION
• Climate impact is essentially determined by production processes, products, and the corresponding choices in energy technology. Traditional measures of sector diversification do not capture this variability because multiple technologies can be present in a sector (e.g., utilities, automotive). Thus, investors should focus on technology diversification in addition to sector diversification.
CHAPTER 3: CLIMATE-FRIENDLY POSITIONING & SIGNALING
DON’T EQUATE EXPOSURE AND IMPACT
• Modifying a portfolio’s exposure to different sectors, companies, technologies, or themes does not directly affect the real economy. The extent to which a climate-friendly objective translates into impact depends on the investor’s positioning and signaling.
DON’T SEEK A FREE LUNCH
• Achieving real climate impact without a critical mass will likely require offering capital with better-than-market terms such as higher risk, lower return, higher transaction costs. Accepting these terms in the short term can mobilize other investors and create benefits over the long term.
DO FOCUS ON MOBILIZING A CRITICAL MASS
• When individual action is insufficient to achieve impact, investors should mobilize a critical mass of investors and / or coordinate a policy signal. Platforms like the Portfolio Decarbonization Coalition and Montreal Carbon Pledge can help achieve these objectives.
CHAPTER 4: CLIMATE-FRIENDLY METRICS
DON’T RELY EXCLUSIVELY ON CARBON FOOTPRINTS
• Carbon footprinting has certain advantages: for instance, companies have experience with its concept, vocabulary, and methodology and it allows a general comparison across sectors. Carbon footprinting also has shortcomings: emissions profiles are based on historic data, which may disregard investments in emissions reductions; it does not always capture cradle-to-grave emissions; and it does not directly capture exposure to green technologies. For nonequity asset classes, green / brown exposure metrics capture a more complete picture of climate friendliness. For listed (public) equity assets, reporting should involve a mix of carbon metrics, green / brown exposure metrics, and climate environmental, social, and governance(ESG) scores.
DO CONSIDER THE EXPOSURE TO GREEN TECHNOLOGIES
• One shortcoming of carbon metrics is their inability to measure the exposure to green technologies. Since the shift to a low-carbon economy is largely a shift toward green technologies, a climate-friendly strategy should use metrics that can measure this shift.
DO DISTINGUISH METRICS BY SECTOR AND ACTIVITIES
• Certain climate metrics are more appropriate for some sectors than others; the same goes for investment activities and objectives. Similarly, some metrics make more or less sense in different situations, such as an investor’s sustainability report or an investment approach.
CHAPTER 5: CONCLUSIONS AND FUTURE DEVELOPMENTS DON’T IGNORE THE CURRENT MOMENTUM
• Limitations of the current metrics mean investors are unable to fully align their climate-friendliness objective to climate policies. Each class of metrics —carbon footprinting, green / brown metrics, and ESG climate scores—has advantages, disadvantages, and complementarity with other methods. However, the full class of current metrics allow investors to understand the concept of climate-related exposure and to respond to the recent momentum.
DO ENSURE METRICS MATCH STRATEGY
• Investors reviewing the landscape of current strategies should focus on the overarching climate objective. To measure their progress, investors should choose metrics that align with their chosen strategies and are appropriate to the asset class in which the strategies are pursued.
DO FOLLOW FUTURE DEVELOPMENTS
• Because several international research initiatives and many ESG data providers are developing the next generation of climate-friendliness metrics to measure the long-term climate impact of financial portfolios, investors should avoid “locking in” to specific performance indicators and allow for the integration of more sophisticated indicators in the near term.