Decarbonizing portfolios without compromising performance


As pressure builds on asset managers to decarbonize investment portfolios, new and innovative forward looking carbon toolboxes show that it can be done without damaging performance.

Across the globe, financial regulators and industry associations are improving transparency around greenhouse gas (GHG) emissions as action intensifies to tackle climate change. Recently, in March 2022, the Securities and Exchange Commission proposed a new set of climate risk disclosure requirements for US public companies, which includes GHG emission data. Together with other national developments, as well as the work of the ISSB (International Sustainability Standards Board), this is a significant step towards standardizing climate-related reporting for investors.

Catastrophic weather events have raised awareness, putting commercial pressure on asset managers to invest largely in ‘green’ companies that have small or shrinking carbon footprints. In 2021, some 42.4% of all funds sold in Europe were marketed under the Sustainable Finance Disclosure Regulation’s two green labels – Article 8 and Article 9, even though the regulation had only been introduced earlier that year. 1

Indeed, asset management companies are asking their portfolio managers to make plans for reducing funds’ aggregate carbon exposures. The Intergovernmental Panel on Climate Change report released in April 2022 increases the sense of urgency, saying that the goal of limiting global warming to 1.5°C can only be reached if there are immediate and deep emissions reductions.

We know that top management at asset management firms have asked for a reduction in carbon footprint in the coming years, ahead of expectations that new regulations will require this,” explains Pierre Bergeron, Cross Asset & Green Bond Strategist at Societe Generale CIB. 

Carbon scores across asset classes

Yet asset managers face a dilemma: how can they cut carbon without damaging investment performance? Today’s trends in equity markets illustrate the problem. With oil and gas prices soaring, the share prices of the companies that extract fossil fuels are outperforming broader equity markets. Simply removing these stocks from portfolios, or even reducing their weights, would come at a cost in terms of performance.

To analyze the trade-offs involved, investors have been increasingly reliant on specialized ESG experts to advise on sustainable investment strategies. This is where Societe Generale and its Research team comes in. In the context of its ‘Invest Without Carbon’ research push, the team has put together a dedicated taskforce to develop forward looking carbon toolboxes – the Corporate Carbon Toolbox and the Sovereign Carbon Toolbox – to allow portfolio managers to reduce carbon while maintaining expected returns and risk, or at least knowing what the cost will be. 

To achieve the most accurate scoring, Societe Generale has partnered with leading carbon expert, S&P Trucost, whose data is used among other providers such as Bloomberg and SBTi. The other arm of the taskforce consists of Societe Generale Cross Asset Research economists and sector analysts who provide expert insights into, respectively, key country economic metrics and forecast, and sector specific carbon reduction strategies. 

Corporate Carbon Toolbox

The Corporate Carbon Toolbox allows to gauge past current and future carbon emissions in equity and credit portfolios through the scoring of European corporations on their environmental performance. Spanning several asset classes, Societe Generale’s Corporate Carbon Toolbox gives equities, bonds and derivatives carbon scores based on four underlying metrics: two quantitative metrics (carbon intensity and temperature trajectory) and two qualitative (Societe Generale environmental score and Societe Generale analyst rating). 

To do so, Societe Generale’s team of experts have worked on creating two data series: the backward-facing environmental score, which provides a broader scope than just GHG emissions, and the forward-looking ‘impact’ score, which measures the quality and efficiency of corporate strategies for reducing future emissions. The four criteria in the toolbox are equally weighted to make up a carbon score, in which a high score implies that the company has an overall superior environmental performance.

Take the oil and gas sector. The tool awards bp, the British oil and gas company, a superior carbon score to its competitors elsewhere in Europe. This is chiefly due to its temperature alignment rating, which attempts to convey the future trajectory of a company’s GHG emissions. Bp's higher exposure to natural gas production, investments in renewable operations, and more active management approach facilitate the company to achieve this target in cutting emissions than its competitors – hence the better rating.

Global Sovereign Carbon Toolbox

The Global Sovereign Carbon Toolbox, built on a unique methodology to score sovereign bonds, is based on country-level greenhouse gas emissions. Sovereigns represent a large asset class within fixed income and are highly exposed to energy and climate risks. While in the past, sovereign bonds have been excluded from a carbon risk and reporting perspective, Societe Generale’s Carbon Toolbox now covers sovereigns by analyzing carbon footprints and providing forward-looking insights to help investors measure, understand, and manage the climate change risks embedded in their sovereign bond portfolio via three main pillars:

• Measuring the sovereign carbon footprint - reiterating the methodology and defining the scope of emissions to include greenhouse gases as a whole, rather than focusing on CO2 alone.
• Building proprietary forecasts - factoring Societe Generale economists’ proprietary country emissions and GDP forecasts for the next decade.
• The aggregated Societe Generale carbon score - combining historical and forward-looking criteria that captures both sovereign carbon performance and emissions reduction implementation.

Fine tuning portfolios

Using the Carbon Toolboxes helps calculate a carbon score for each issuer in a portfolio as well as for the portfolio as a whole. Clients can then effectively decarbonize their portfolios by selecting to replace equities, bonds or derivatives scoring poorly with those that score well. They can judge if there will be any cost to investment performance as the tool provides forecasts of performance. 

Depending on the asset class, the tool provides relevant forecasts. In the case of bonds, for instance, it shows return forecasts including the future spread. Another possible benefit of the tool is that performance may be correlated with carbon footprint. “We believe that the market will be sensitive to carbon footprint analysis when pricing assets, particularly for the bond market which is less liquid than the stock market,” notes Bergeron. “If a company has a big carbon footprint, this will have a significant impact on the bond prices and the bond spread.”

In order to achieve substantial emissions reductions, we believe that significant change is needed. All business sectors, especially electricity, agriculture, housing, and automobile, are having to adjust their models to fight climate change. With these new toolboxes, investors can make more informed decisions to secure a greener portfolio without sacrificing their returns. It’s all about combining environmental analysis and investment return forecasts”, adds Bergeron.

While some large asset managers can do this analysis in-house, others do not have the resources… yet all asset managers must find a way to decarbonize investment portfolios With COP27 just a few weeks away, which includes a thematic day on climate finance, the role that the financial industry has in fighting climate change will gain traction. Asset managers will come under still greater pressure to cut carbon while minimizing any implications for performance.

To find out more about our toolboxes click here:

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1 Source: Morningstar. SFDR Article 8 and Article 9 funds: 2021 in review. 4 February 2022.