What is the temperature of your portfolio?
Written by By Kevin Jarussi and Luke Wilcox, ethos ESG
As climate change continues to wreak havoc on our planet, with no signs of abating, the investment industry continues to ask itself what it can do to help keep us under the 1°5C threshold set by the Paris Climate Agreement. With the ever-increasing urgency of addressing climate change, mutual funds and ETFs have an important role in helping to finance the transition to a sustainable economy.
Despite the fact that $43 trillion in assets (almost half of global assets under management) are now linked to a net zero emissions target, scientific consensus shows that the 1°5C target set forth is optimistic and that current global policies leave us falling well short of it. While the focus on net zero will force investors to look for cleaner investments, many of the high emitters are dragging their feet. Many long-term climate commitments have been made, but very few have enacted robust policies.
Carbon Neutral Certification
Still, products are being launched throughout the investment industry aimed at both getting us closer to net zero as well as helping investors understand how their investment choices contribute to global warming.
ethos ESG, an ESG data and software company based in the United States, has recently developed, in conjunction with Change Finance, a carbon neutral certification program for mutual funds, ETFs, separately managed accounts (SMAs), portfolios, and other investment products.
Change Finance’s U.S. Large Cap Fossil Fuel Free ETF (CHGX) is the first ETF in the United States to be certified as carbon neutral. More will certainly follow.
Through the certification, ethos ESG performs an independent analysis of a fund’s carbon footprint and carbon credits (offsets) to verify whether the fund is carbon neutral during a specified period. The carbon footprint consists of verified Scope 1 and Scope 2 emissions of every holding of the fund. Verification includes widely-used statistical methods such as linear regression to compare company self-reported emissions to peers and expected emissions.
Linear regression involves using a best-fit model for predicting emissions, based on testing of 15+ independent variables related to carbon emissions. These include carbon intensity per million dollars of revenue, carbon intensity relative to peers, net zero commitments made, and historical reduction in scope 1 and 2 emissions, among others. ethos ESG uses existing data from 1200+ companies it feels have high-quality reporting for their carbon-related data.
Carbon Neutral Funds
When a fund becomes certified as carbon neutral, ethos ESG makes this information available to advisors and other capital allocators, in addition to granting the fund rights to promote through any channel it chooses.
The launch of this program is timely as the shift toward investments that prioritize climate action has intensified. This trend is likely to continue owing to several factors:
- The pandemic has accelerated the shift towards more ESG and climate friendly solutions.
- The current US administration has brought a measure of renewed optimism for the fight against climate change, including through changes within the Securities and Exchange Commission (SEC) such as the creation of a climate and ESG task force
- The EU Sustainable Finance Disclosure Regulation (SFDR), which went into effect in March 2021, requires greater transparency and accountability on the sustainability of financial products
The carbon neutral program’s aim is to help catalyze the shift toward a carbon neutral economy and alignment with the Paris Agreement (limiting global warming to 1.5°C). By increasing awareness among capital allocators of funds that are actually carbon neutral, we can remove some of the noise around carbon neutrality, and other funds will be encouraged to follow suit. Credible decarbonisation of portfolios is a must.
Also a must is the need to add transparency on the temperature change level of investment portfolios. In order to move further toward carbon neutrality, investors must be able to understand how their investments are aligned with the 1°5C goal set by the Paris Climate Agreement.
Paris Agreement: Portfolio Alignment
ethos ESG has recently added a “global warming potential” graphic to its platform, designed to show the degrees Celsius of global warming that the portfolio is aligned with. It indicates how well aligned the portfolio is with the Paris Agreement on climate change mitigation, adaptation, and finance.
The degrees Celsius warming of the portfolio is calculated as the weighted-average degrees Celsius warming potential of portfolio holdings, using current emissions amounts and emissions reduction targets from the Science-Based Targets Initiative.
ethos ESG calculates current emissions intensity (scope 1, 2 and 3 metric tonnes of CO2 per $1M USD in sales) for portfolio holdings, using company filings and third party carbon data sources. ethos ESG then determines the global warming pathway that the intensity is aligned with, using data from the Climate Action Tracker, which estimates the total amount of global CO2e that can be released per year between now and 2100 to meet 1.5°C and 2°C scenarios. ethos ESG combines this data with global GDP projections to estimate average emissions intensities that are aligned with varying warming scenarios.
Understand the Impact on Climate Change
This feature allows investors to understand the global warming potential of their current portfolio, the warming potential of a proposed portfolio, and how these compare to any number of funds used as a benchmark. By providing this data, ethos ESG helps investors understand the impact of their investments on the climate.
Scientific consensus tells us that in order to keep under the 1°5C target, net-zero will need to be achieved by 2050. Though that goal appears increasingly out of reach, by providing a pathway for mutual funds, ETFs, and other investment products to become carbon neutral, and by showing investors their money’s impact on global warming, ethos ESG is providing some of the tools needed to help reach that goal.