The climate-impact dashboard is part of a 3-D investment framework that balances risk, return and impact. This includes total portfolio thinking, long-horizon investing, impact investment strategies, system-level engagement and strategic partnership between asset owners and asset managers. Here Tim Hodgson lays out eight guiding principles to help shape a climate-impact dashboard.

 

We believe the idea of 3-D investing – risk, return and impact – will be hugely significant for the industry. And in terms of climate impact reporting we lay out some fundamentals we believe should be used by investors.

But first, we should make an important distinction between climate-risk reporting and climate-impact reporting. The former importantly addresses the impact of climate change on investment portfolios while the latter focuses on helping investors understand the extent their investment activities are affecting the climate (for better or for worse).

Climate-risk reporting is already well catered for by the risk and return dimensions and so, here, we focus on the impact of investment portfolios on climate change.

When it comes to climate-impact reporting, we believe a dashboard comprising multiple measures should always be used, because no single metric can tell the whole story. To this end we have developed eight guiding principles to help shape a climate-impact dashboard. We start with purpose (#1).

There are many reasons why investors might commit resources to measuring and reporting on the climate impact of their portfolios and most, but not all, of them are good. Some investors do it because they want to proactively report their impact to key stakeholders or address client demand for this information. It can be about better understanding whether there has been sufficient progress towards some pre-agreed goals such as Paris alignment or net-zero emissions. Or, it could be simply adhering to government regulations to measure and report impact. Whatever the purpose is, the impact report should be explicit about it. We see this as the first safeguard against greenwashing.

Thereafter, it is logical that milestones or interim targets (#2) – both level and time scale – should be clearly defined. Many countries and, increasingly, institutional investors have set net-zero emissions by 2050 as their primary climate goal. The fact that this goal is three decades away can lead to a lack of urgency for action. Interim targets are therefore necessary for keeping track of the shorter-term progress, and examples could include a percentage reduction in emissions by [date], a percentage allocation to climate solutions by [date], and/or a temperature rating of [X] degrees Celsius by [date].

The actions taken (#3) to achieve the targets should be documented and the metrics and evidence (#4) reported should allow a simple assessment of progress towards targets. We group these two principles together so as to not conflate investor contribution (ie investor actions) with investee company impact (the metrics). It is important that investors document where they have sought to influence investee company behaviour, but claiming causality between that influence and changed behaviour will be the exception rather than the rule.

There is no doubt that the complexity of this subject requires multiple and complementary metrics (#5), so in constructing a climate-impact dashboard, we suggest investors consider the following:

  • A balance between backward-looking and forward-looking metrics and between absolute and relative measures
  • Use as few metrics as possible, but not too few
  • Ensure the dashboard is user-friendly and design techniques should be used where behavioural issues can be anticipated (eg colour coding as signposts)
  • Qualitative metrics can be as valuable as quantitative ones.

When it comes to measurement, there is often a trade-off between validity and materiality. A classic example is past performance returns: they have very high validity as independent experts would calculate the same value, but very low materiality as they do not predict the future returns and therefore are not decision useful. We suggest that a climate-impact dashboard can include the following three categories of metrics:

  • Portfolio emissions footprint – these metrics report the amount of greenhouse gas emissions released by the portfolio companies, in absolute terms and/or normalised by some measure (eg $ invested, volume of production, $ revenue etc)
  • Portfolio alignment – the purpose of these metrics is to provide an indication on the likely/projected carbon pathway of portfolio companies relative to a carbon budget consistent with a net-zero transition
  • Portfolio contribution to climate solutions – the metrics in the above categories could (will?) look poor if the portfolio companies are actively building climate solutions. The metrics in this category should be selected to show investor actions in a true light. They should also encourage investors to engage actively with their portfolio companies to create solutions and grow new or undersupplied capital markets in line with impact goals.

Being transparent (#6) about any limitations inherent in what is being reported addresses the challenge that many metrics currently used in climate-impact reports have relatively low validity. Portfolio temperature ratings are a clear example. Given the forward-looking nature of the metric, the warming potentials for each portfolio company are naturally an estimate. It is an intuitively attractive concept that disguises the compounding of many poorly constrained uncertainties, assumptions and implicit value judgements. While we believe it has its use as part of a holistic dashboard, it needs to be interpreted with care by explicitly acknowledging its limitations. The same principle should apply to all metrics presented in a dashboard.

It follows that a climate-impact dashboard is incomplete without a supporting narrative (#7). Metrics are simply data, which still need to be interpreted and processed before they become something meaningful to the people who receive them. Narratives provide context, and aid interpretation and evaluation of achievements and progress. The rationale is simple: from a behavioural perspective, human brains process narratives and storytelling much better than data. The narrative helps the reader make sense of the metrics, and the metrics allow the reader to challenge the narrative.

Finally, investors need to be willing to evolve (#8) their climate-impact dashboard over time to ensure that it remains relevant and appropriate as new data and better techniques become available. We are at the very beginning of climate-impact reporting. It is inconceivable that we will not get better at it as we learn more.

The climate-impact dashboard is a valuable building block of a grander vision – a three-dimensional (3-D) investment framework that balances risk, return and impact. This framework is an amalgamation of various elements including total portfolio thinking, long-horizon investing, impact investment strategies, system-level engagement and strategic partnership between asset owners and asset managers. In all of these areas, thinking and practice have advanced in recent years. However, the successful creation and mass adoption of the 3-D investment framework hinges on integrating them all seamlessly at the organisation and system level. Operating well-designed climate-impact dashboards at portfolio level would undoubtedly help realise this grand but essential ambition.

Tim Hodgson is co-head of the Thinking Ahead Group, an independent research team at Willis Towers Watson and executive to the Thinking Ahead Institute.

Leave a comment