Michael Sher discusses key climate metrics and how to use them effectively to reduce climate change
In recent years we’ve seen extraordinary droughts in California, Cape Town, Chile and Italy; record flooding in Brisbane and Durban; and record temperatures in Antarctica. Scientists globally attribute these climate changes to rising concentrations of atmospheric carbon dioxide and other greenhouse gases, caused by human activities.
Many aspects of climate change and its causes are measurable. While some of these metrics only allow us to monitor changes, others indicate the impact of the actions that actuaries and investors can take to slow climate change. Target-setting can help us to prioritise allocation of time and resources between possible actions.
What metrics can tell us
As metrics are statistics, their usefulness depends in large part on the narrative around them. For example, measured portfolio emissions can be reduced by divesting from high-emission companies or encouraging them to lower their emissions.
Some people argue that divestment causes no real-world reduction in emissions, so a divestment-focused investor’s narrative is important if it is to show how it has reduced both its risk and that of the world. This will help to avoid accusations of greenwashing – when a company takes or misrepresents actions to convey the impression that it is more environmentally sound than it really is.
Using metrics that cover different areas of stewardship can also help investors to avoid greenwashing. For example, lower portfolio emissions (even if due to divestment) accompanied by a high number of shareholder resolutions urging a material reduction in emissions present a different picture to a fall in portfolio emissions but a very low number of engaged-with companies.
What metrics are both practical and useful?
Different metrics have different use cases. For example, forward-looking metrics are aspirational and can help us to understand the potential risk we face. Historic metrics, on the other hand, allow us to assess where we are and what our direction of travel is.
Metrics also differ in terms of what they represent – for example, some, such as income statements, relate to a time period, while others, such as balance sheets, relate to a point in time. We can avoid distortions due to changes in holdings by weighting them by the proportion of the period for which they were in the portfolio.
PD: Proportion of portfolio with emissions data
Use case: Assessing the coverage of other data-based metrics
Calculation: Using market value of holdings: PD = market value of holdings with data/total market value
Advantages: Useful to gauge how much we can know of our portfolio
Disadvantages: Doesn’t indicate effectiveness of activity; changes in holding size can impact market value-based metric, distorting informational improvements
Notes: One could also use other relevant metrics for weighting if that adds insight, eg revenue
NCE: Number of companies engaged with
Use case: Can indicate whether an investor or manager is genuinely interested in change
Calculation: NCE = sum of relevant engagements in period
Advantages: Simple to calculate and implement
Disadvantages: Open to greenwashing risk – eg a simple mention of emissions in a meeting, with no ongoing follow-up, could be viewed as an ‘engagement’. But is it?
CF: Carbon footprint: a portfolio’s proportionate share of measured or estimated emissions from holdings
Use case: Assessing real-world emissions from a portfolio. Year-on-year changes can indicate the impact of investor actions on portfolio emissions alone, or in effecting a change in ‘world emissions’
Calculation: CF = sum of all scope 1/2/3 emissions for holdings in portfolio (as desired and available) × market value of holdings (debt + equity)/market cap of names held × proportion of period held
Advantages: Relatively available for listed assets, for scope 1 and 2 emissions; helpful for assessing portfolio vulnerability to carbon-based policy measures, eg carbon taxes
Disadvantages: Unreliable for scope 3 emissions; data for unlisted assets is sparse; divestment and tilting can directly reduce portfolio emissions
Notes: Contrasting theories exist about whether divestment leads to reduced real-world emissions from companies, or whether there is sufficient non-engaged capital to fill the resulting vacuum. If the latter theory is true, then divestment can be used to ‘virtue signal’ climate-friendly actions when in fact none have been taken (see engagement metric)
REALTH: Reduction in emissions (absolute) from long-term holdings
Use case: Assessing real-world reduction of emissions from companies in portfolio
Calculation: Same as CF, but limited to holdings held for more than a certain period, eg 18 months
Advantages: Same as for CF, and: indicates real-world emissions changes from key holdings; is difficult to manipulate
Disadvantages: Similar to CF
CVAR: Climate value at risk: change in value of portfolio/asset due to climate change
Use case: Forward-looking. Useful for giving a sense of risk exposure
Calculation: For investors concerned about cashflows, this can be extended to reflect possible changes in portfolio cashflows
Disadvantages: Based on a wide range of assumptions – metric value is critically dependent on assumptions of timing, region and sectoral impact; inflation and changes in market value will distort this year on year; metric can be improved via divestment without requiring the investor to do things that reduce risk more broadly
Notes: Debate continues as to whether divestment is as effective as engagement in reducing real-world emissions. The metric only captures the impact on company supply chains, logistics and customers if assumptions reflect this. Is calculated by third parties
Emissions intensity
Use case: Indicates the carbon content for each unit of measure, eg £m profit or revenue generated by portfolio
Calculation: CF/sum of revenue for holdings. Key methodology is the standards published by Partnership for Carbon Accounting Financials (PCAF)
Notes: One can use sum of earnings rather than revenue. In investments, one might use investment size
ITR: Implied temperature rise: indicates what sort of increase in temperature the portfolio may be considered to be supporting
Use case: Useful for showing an investor’s ‘personal’ alignment with Paris goals
Calculation: The calculation requires a table of temperature rises expected for a given level of world emissions; portfolio ITR is then simply the temperature rise corresponding to scaled-up CF, ie CF × world market cap/portfolio market cap
Notes: Based on a large number of assumptions. Assumes whole-world economy develops per the portfolio – but it’s impossible for the portfolio to reflect the split of actual economic activity by region and sector. Risk of greenwashing: can be improved via divestment without effecting any real-world change in emissions. Debate continues as to whether divestment is as effective as engagement at reducing real-world emissions
Where to from here?
Understanding the calculation, use and shortcomings of metrics is enormously empowering. For those who calculate and publish these metrics, they allow us to credibly demonstrate our intent and effectiveness, as well as comply with regulator and stakeholder demands. For those who use them, they allow us to hold others to account and take actions that make real changes to the world and to the emergence of climate risks.
As Samuel Beckett said: “You’re on earth. There is no cure for that.” All of us will be affected by wide-ranging climate change, and metrics can be a key enabler in helping us create a better future on the earth.
Michael Sher sits on the Board of the IFoA Sustainability Volunteer Group and leads a small team in building a user-friendly asset liability climate model
