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Do you know how hot your portfolio is? You’d be forgiven for not knowing what this means. It refers to the trendy practice of working out whether the companies you invest in will hit global warming targets or not.
It will also come as no surprise that portfolios are often not in line with the goal of preventing the world’s average temperature from rising by above 1.5 degrees Celsius.
Even the Japanese government pension fund (GPIF) — the largest in the world, and one that takes sustainable investment seriously — has an implied temperature rise of 2.5-2.6 degrees.
Calculating and trying to lower the heat in your portfolio would seem a reasonable way to measure progress as a sustainable investor. But there are some major flaws with this approach.
First, how are investors making this calculation? Many rely on a methodology cooked up by index provider MSCI called the “implied temperature rise”. This works out the remaining carbon budget for the world to prevent temperatures rising more than 1.5 degrees, and allocates this budget to 12,000 public companies on a weighted basis, according to the size of their revenues.
A tool on their website can then be used to search various companies. Exxon’s implied temperature rise is above 3.2, putting it in the worst category of “strongly misaligned” — no huge surprises there. Ørsted, an energy company that has made a pronounced pivot to renewables, comes in at 1.6. Tesla, the electric vehicle company, is in line with the goal at 1.5. British American Tobacco’s implied temperature rise is just 1.3 degrees — a reminder that sustainable and ethical investment are not synonymous.
I had quite a lot of fun playing around with this, and if you had a portfolio of direct equities it would be fairly straightforward to work out how “hot” it was.
But when you look at how the implied temperature rise is calculated, it’s not a rigorously scientific measure. Various assumptions are made.
Collecting the data is one issue. In the UK, large companies are required to disclose their scope 1 and scope 2 emissions — but not scope 3 emissions. These are those produced in their supply chains, which often account for the majority of a company’s carbon footprint.
US companies don’t have to disclose emissions at all, though new regulation is about to change that.
This dubious data means that anyone trying to calculate a company’s carbon footprint will have to make some educated guesses. Calstrs, one of the world’s largest pension plans, had its own headache recently when it said that it couldn’t accurately say what its 2023 carbon footprint was, due in part to “significant data and calculation issues”.
Working out how hot your portfolio is also involves looking at the carbon emissions targets a company has set. Ideally, a company will have a net zero target for 2050 but also some sort of meaningful shorter-term goal for 2030 as well. Net zero targets 26 years into the future by themselves are increasingly viewed with suspicion. MSCI does say that in addition to analysing a company’s emissions targets it does a “credibility analysis” — which at least sounds like a healthy degree of scepticism is built in.
But there are other issues: the weighting of a company’s carbon budget — those with larger revenues get a larger budget — leads to some counterintuitive results. Amazon’s implied temperature rise is 2.6C, more than oil giant BP’s at 2.5C, for example.
The wider point is whether it even makes sense to work out how hot your portfolio is. A cooler portfolio could mean you’re missing out on the energy transition. It could also mean you’re investing with fund managers who choose not to engage with the companies they invest in and push them to set better targets. A hot company this year could become a much cooler company in a year’s time if it had engaged shareholders.
Japan’s GPIF, for example, says that it favours this sort of active engagement with the companies it invests in, which means it could be choosing hotter companies now in the hope of convincing them to be cooler. That could be one reason why GPIF’s implied temperature rise looks high for an investor that cares about climate change.
Professionals in the business of trying to make companies reduce their carbon footprint are more likely to want to use these types of figures because they need some accountability; some way of measuring things.
And for many retail investors, it sounds like a nice idea. A study last year by Kana Earth found that 69 per cent of retail investors wanted their fund managers to state the carbon footprint of their portfolio — though they may not have known how inexact a science this is.
Ultimately, in attempting to calculate an exact temperature for your portfolio you’re going to have to make some assumptions, some of which lean more towards finger-in-the-air stuff than the scientifically measurable. That may be acceptable for some people. They may enjoy trying to refine the calculation and move the dial towards the science. If you like figures and feel it’s motivating to measure performance in this way, go for it.
For the rest of us, there’s the sniff test. You don’t need a full analysis to work out whether your oil holdings are raising the temperature of your portfolio. One of the biggest decisions a sustainable investor has to make is whether to divest or engage. If you ditch all your traditional energy holdings — if you can’t take the heat — your portfolio will be cooler. But if you pick companies where you plan to vote at shareholder meetings, or fund managers with a good voting record, you could have more impact, even if your portfolio is hotter. Some of us prefer to stay in the kitchen.
Alice Ross is the FT’s acting international economy news editor. X: @aliceemross
