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Thursday, 22 April 2021

What’s a “warming rating” for a portfolio manager, and why should you care?

Warming to climate change is a new success metric: Money managers’ performance is now being measured in terms of their carbon footprint, with “portfolio warming” emerging as a new metric by which to judge the success of investments, Bloomberg reports. Rather than focusing purely on higher gains, companies’ outperformance is subject to the “warming potential” of the underlying assets in their investment bundle. While calculating the “implied temperature” of a portfolio is a new advent, leading some critics to question the accuracy of the estimates, it is becoming increasingly important to investors as nations seek to adhere to the 2015 Paris agreement, which commits nations to working towards a 2°C limit to global warming.

Climate risks have been at the forefront of firms’ ESG priorities for some time now, with 338 large companies globally reducing their emissions by 25% between 2015 and 2019, according to a 2021 report by UN-backed Science Based Targets.

How does one measure a portfolio’s “warmth,” you ask? Investment advisory firm MSCI has developed a methodology for assessing a company’s contribution to climate change through its carbon emissions. This will tend to be higher if the firm is in a carbon-heavy sector, such as fossil fuel extraction or heavy industry, and if its supply chain involves emission-heavy transport and logistics routes. The metric also factors in the emissions likely to be produced by the end users of the product, making the calculation extremely complicated. Companies are then deemed to fall into one of several categories: Business as usual (meaning the companies are not effectively reducing emissions), or 3°C, 2°C, 1.5°C, and so on — the higher the temperature category, the less climate-friendly. A portfolio’s entire warming potential is calculated based on the weighted aggregate of the warming potential of the companies comprising it.

Taking assets’ temperature is gaining in popularity: UK insurer Aviva and Japan’s USD 1.7 tn Government Pension Investment Fund have released data on warming potential, while New York-based BlackRock plans to do the same for some of its USD 8.7 tn-worth of assets. “Managing climate risk has become an increasingly important tenet of the investment process as investors want to be able to measure the impact of climate change and build portfolios resilient to climate risk,” said MSCI’s head of ESG, Remy Briand.

And businesses might actually be better poised to measure global warming than governments: Money managers with fingers in many pies may be better able to evaluate the scale and rate of the climate change caused by the companies in which they have invested, and may also be in a better position to use their capital as leverage to pressure companies to shift to climate-friendly practices.

But don’t expect corporations to enjoy being held to account: Despite Amazon and Apple’s commitments to be carbon neutral by 2040 and 2030 respectively, MSCI gave Amazon a warming potential of 3.9°C and Apple a warming potential of 2.9°C. Microsoft also gets a 2.1°C score, in contrast with its pledge to zero-out emissions by 2030.

Adopting warming ratings as a mainstream metric will take a double pronged push: “The warming-potential concept requires a far broader public-private effort that cannot be achieved by investors alone,” said Ulrike Decoene, head of corporate responsibility at ins. provider Axa, which is a leading adopter of the climate-friendly portfolio. Adopting the metric as a standard could also encourage further data disclosure on the part of companies and allow us to get a broader picture of climate change risks to the planet. MSCI found that only 16% of one of its indexes covering 9k global stocks were on track by the end of 2020 for a 2°C temperature rise, with only 5% coming in below 1.5°C, suggesting much more needs to be done to keep portfolios cool.

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