Since publicly listed equities usually make up the largest portion of institutional investor portfolios, it’s critical they aren’t left out of impact investing, said Deirdre Cooper, portfolio manager for global environment at Investec Asset Management Ltd.
With the energy transition away from carbon-intensive sources already underway, a massive amount of capital still needs to be deployed to fully address global climate change, she said during an event hosted by Global Capital in Toronto on Wednesday.
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Earlier in her career, Cooper learned just how difficult it can be to adequately measure a given portfolio’s carbon impact. Nearly a decade ago, she built her first environmental portfolio, but when her then firm reached out to a third-party company to measure its carbon footprint, it told her the portfolio’s carbon output wasn’t any less than global equities on average. “I said, ‘No, no, our environmental portfolio is significantly better than global equities.’ And, of course, what we realized is that there are a lot of issues with carbon footprinting.”
Cooper’s portfolio had only been measuring scope 1 and 2 carbon, which cover the emissions produced by the actual business activities of a company. It didn’t account for scope 3 carbon, which measures the emissions in the business’ supply chain and those resulting from the use of goods once they’re sold. “Approximately 75 per cent of the carbon footprint of the market sits in scope 3,” she noted.
For example, while the actual extraction of coal from the ground isn’t especially carbon intensive, the real damage is done in burning the coal. “So our environmental portfolio had one or two utilities that were 80 per cent wind and solar but had some fossil generation,” said Cooper. “And that totally destroys your carbon footprint. So when we thought about measuring carbon impact, we found it was really important to develop something where we could measure scope 1, 2 and 3.”
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While managers have digested lessons like this one, the conversation is still dominated by the risk factors presented by climate change. But they should shift towards the opportunities presented by the energy transition, said Cooper, noting she’s started to focus on screening for positive impact.
“If I’m a company that sells insulation to a building, the fact that the insulation makes the building much more energy efficient isn’t in my footprints, it sits in the building of it. But you can easily calculate across their products, as they go into each building, how much the energy use declines, what the carbon footprint of that grid is and what the carbon avoided is.”
The subsequent investment universe created on this principal includes about 700 companies around the world. “We screened global equities for companies that had at least 50 per cent of their revenues associated with the energy transition. We call that environmental revenues,” said Cooper. “And then we screened as to whether their products and services had quantified carbon avoidance.”
Notably, the investment universe outperformed the MSCI All Country World index significantly over the past 10 years with the exception of 2018, which saw a major slump.
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“That doesn’t surprise me because I think global equity markets significantly underestimate the opportunity that exists for those companies exposed to the energy transition,” said Cooper. “What was surprising was that there’s little overlap between those companies in our universe and global equity markets. About a third of our universe is in MSCI ACWI, about 10 per cent of its weight. So we have this universe of companies exposed to an interesting structural growth area, but are probably not owned by most global equity investors.”
For Cooper, the most interesting part of the project is being able to measure and report on the performance of individual companies, not just the universe. “We report to our investors [on] what was your carbon avoided last year, what was it this year and watch that grow over time.”