This is the second blog in series examining the steps portfolio managers need to take to reach the goal of net-zero carbon dioxide emissions in their investment strategies by 2050. The first blog asked, “What is net zero, and what are the implications for portfolio managers?” In this blog, we look at how to assess the carbon intensity of portfolios to create a baseline carbon footprint against which to measure improvements over time.   

Many new regulations are coming into play that will have a direct impact on portfolio managers and their assessments of environmental, social, and governance (ESG) issues. While asset management firms emit relatively few greenhouse gases (GHGs) to run their operations, they are likely to finance significant levels of emissions through their investments in other companies. These financed emissions need to be understood if a firm is to effectively assess its GHG footprint and disclose its management of sustainability risks and opportunities.  

Carbon footprinting is a typical starting point for assessing the GHG emissions associated with a portfolio, as it offers a baseline from which to mitigate risks and drive investments toward lower-carbon alternatives. Carbon is measured across 3 Scopes:

Scope 1: All direct GHG emissions.

Scope 2: Indirect GHG emissions from consumption of purchased electricity, heat or steam.

Scope 3: Other indirect emissions, such as the extraction and production of purchased materials and fuels, transport-related activities in vehicles not owned or controlled by the reporting entity, electricity-related activities (e.g., T&D losses) not covered in Scope 2, outsourced activities, waste disposal, etc.

There are four methods to calculating the carbon footprint:

Absolute Footprint

The 'absolute' footprint is calculated by apportioning emissions of investees or loan recipients to the provider of finance. An apportioning factor is arrived at by dividing the total value of the finance provided to any given company by an estimation of that company's total value. In this calculation, equities, bonds and loans are all treated equally as 'sources of finance'. The denominator used as an estimate of a company's value will depend on whether or not the company is listed. For listed companies, Enterprise Value (EV) is used as the denominator.

Carbon-to-Revenue

The C/R is calculated by dividing the sum of all apportioned emissions, with the sum of all apportioned revenues across an investment portfolio or loan book. This metric gives an indication of how efficient companies in a portfolio or loan book are at generating revenues per tonne of carbon emitted.

Carbon-to-Value

The C/V is calculated by dividing the sum of all apportioned emissions, with the sum of all finance extended (equity, debt or loans) across the investment portfolio or loan book. This metric gives an indication of how efficient companies in a portfolio or loan book are with respect to the carbon emitted per dollar of financing received.

Weighted-Average Carbon Intensity(TCFD recommended)

The WACI is calculated by summing the product of each company's weight in the portfolio or loan book with that company's carbon-to-revenue intensity. The avoidance of apportioning with the WACI approach means that there is no direct connection to real-world emissions. Instead, this metric gives an indication of how 'exposed' from a financial perspective a portfolio or loan book is to high (or low) carbon intensity companies.

To quantify financed emissions in a way that is both meaningful and actionable, it is important to create a footprint that captures carbon by following three key steps:

1. Review all the securities in a portfolio and determine the Scope 1 and 2 emissions for each related company in tons of CO2 per year. (Scope 3 can also be considered but was not in this analysis)
2. Assess a portfolio manager’s ownership of each company based on the value of holdings of investments in the portfolio as a percentage of a company’s enterprise value.
3. Multiply the ownership percentage by the relevant carbon emissions and sum all companies to create the absolute carbon footprint of the portfolio (Apportioning method), Which you can then normalize by revenues (C/R) or value invested (C/V).

As an example, Exhibit 1 below shows inputs for a carbon footprint calculation for a portfolio manager invested in the S&P Global 1200, while Exhibit 2 provides a visual representation of the footprint. The analysis was conducted as if the portfolio manager was fully invested in the index. If it only represents 5% of the asset allocation strategy, it would need to be scaled accordingly (so, carbon footprint times 5%). Emissions are allocated using the enterprise value of each company — thus, owning 1% of Exxon shares would mean owning 1% of its emissions. 

Exhibit 1: Carbon Company Breakout S&P Global 1200, Carbon Apportioned, Weighted Average Carbon Intensity (WACI), Carbon to Revenue (C/R) Intensity and Carbon to value (C/V) Intensity

Source: S&P Global Trucost, March 2021. For illustrative purposes only. 

Exhibit 2: Visual of Carbon to Revenue (C/R), Carbon to Value Invested (C/V), WACI and Carbon Apportioned by Scope for the S&P Global 1200 

Source: S&P Global Trucost, March 2021. For illustrative purposes only. 

Market participants constrained by certain style factors or geographies can still manage their exposure to carbon. Environmental attribution analysis of portfolios or benchmarks shows us that positive or negative carbon choices are possible within sectors through low-carbon stock selections. With quantitative, robust, and consistent data at hand, funds can be optimized to favor more carbon-efficient companies, regardless of the investment strategy deployed. We will look at this in the next blog. 

Easing the Calculation of a Carbon Footprint

Carbon footprinting often requires highly granular data on thousands of companies and asset classes. S&P Global Trucost (“Trucost”) provides a number of databases that can assist with the analysis, including: 

Trucost Environmental Data that contains information on the direct and supply chain environmental impacts for a universe of over 15,000¹ companies, representing 98% of global market capitalization. Information is updated annually using a mix of disclosed and, where gaps are present, modeled data and covers carbon and other pollutants, water dependency, natural resource efficiency, and waste disposal.

¹Data as of October 2020.

Read the next blog in this series: Constructing Carbon-Sensitive Portfolios.