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Vitali Kalesnik Are you really investing in a smaller carbon footprint?

Climate change is increasingly becoming an investment risk for equity investors. Whereas, carbon emissions may be associated with declining business, stranded assets (prematurely depreciated assets) and potential future liabilities, those companies able to help reduce carbon emissions can be excellent investment opportunities. 

Equity investors have an important role to play in improving the environment and mitigating climate change. Yet to fully appreciate the risks and help mitigate climate change, investors need accurate carbon emissions data. Remember the old adage garbage in, garbage out (GIGO)? Today, only about half of all emitting companies around the world report their emissions, and those who do report, do not follow a single standard. Both of these limitations create data inconsistencies. 

The data providers used by equity investors to make their ESG decisions estimate the missing data using a variety of models. Estimated data of any type are noisy, but their wide use reveals a tacit assumption that they are a satisfactory substitute for company reported emissions. Our new research debunks this view. 

After analysing carbon data from four major carbon data providers from 2010 to 2016, we find that estimated emissions data are 2.4 times less effective than reported data in identifying the 5% worst emitters. These 5% of emitters are responsible for more than 80% of total global emissions.  

Data providers also evaluate forward-looking emissions which could be extremely valuable to equity investors in identifying future ESG risks and opportunities. Instead, we find the estimates predominantly reflect company size and industry information and consequently do not help investors identify the green companies in brown sectors, further undermining investor actions.

Because companies are not required to report their emissions, investors are left with only guesstimates. Our research indicates that mandatory reporting under a single global standard is likely to be the only possible solution .

Until we have mandatory reporting, equity investors can and should incentivise companies to voluntarily report their carbon emissions. For example, one of the features of the recently launched RAFI Multifactor Climate Transition Index is to underweight companies that do not report their emissions as a means to encourage companies’ self-disclosure. Increased reporting can go a long way in addressing the GIGO problem investors face today. Without accuracy, investors’ well-meaning actions can quickly lose efficacy and expose them to excessive and underappreciated risks.

*This article was part of a paper titled ‘Green data or greenwashing? Do corporate carbon emissions data enable investors to mitigate climate change’. 

 

Vitali Kalesnik is a partner and senior member of Research Affiliates’ investment team. He leads research and business strategy in the European region as director of research for Europe.

 

This article was originally published in our Opto Magazine. You can purchase copies on our Opto Shop.

Disclaimer Past performance is not a reliable indicator of future results.

CMC Markets is an execution-only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although we are not specifically prevented from dealing before providing this material, we do not seek to take advantage of the material prior to its dissemination.

CMC Markets does not endorse or offer opinion on the trading strategies used by the author. Their trading strategies do not guarantee any return and CMC Markets shall not be held responsible for any loss that you may incur, either directly or indirectly, arising from any investment based on any information contained herein.

*Tax treatment depends on individual circumstances and can change or may differ in a jurisdiction other than the UK.

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