Net zero alignment: Assign portfolio managers strict carbon budgets

A new paper outlines how investors can align their portfolio to science-based carbon budgets consistent with 1.5 degree of warming. Speaking at Sustainability in Practice at Cambridge University, Frederic Samama, head of strategic development, S&P Global Sustainable1 and co-author of Net Zero Carbon Portfolio Alignment, argued that the methodology has an 83 per cent probability and only a negligible tracking error in an approach that works for both active and passive investment.

Samama wrote the paper with Imperial College’s Marcin Kacperczyk and Columbia University’s Patrick Bolton. The methodology also establishes an exit roadmap for carbon-intensive corporates, generating a form of competition to decarbonise within each sector, he argued.

Samama said the research paper was born from the realisation that trillions of dollars is now seeking to align with net zero commitments – around $130 trillion, of which a growing proportion is now backed by legally binding commitments from investors in Europe, Japan and Canada. If a sufficient mass of investors aligned their portfolios to a net-zero target, then companies will be more incentivised to follow suit, he said.

Carbon budgets

The methodology assigns portfolio managers an annual carbon budget compliant with a 1.5 degree objective. From this they can reshuffle their portfolio within these constraints.

“The sum of the carbon budget mirrors the one prevailing at a planet level,” he said. “What is true for the planet, should be true for all forms of financing.”

Portfolio managers’ carbon budgets will be adjusted annually, and he said the carbon budget would be expressed on a level with emissions rather than intensity.

forward looking assessment

He said the process would enable investors to see what their portfolio will look like years hence – and to see which companies they will have to exit in the future.

“They can build a world map of carbon intensive sectors,” he said.

This knowledge will incentivise companies to accelerate reducing their carbon footprint. In effect, it will put companies  in a competitive race to decarbonize to maintain their place in the portfolio.

“It will create a form of competition to accelerate the transition.”

He said if corporates fall out of portfolios, they can come back in once they get back on track towards net zero and envisages investors shaping a process of active engagement that creates competition in the sector. Samama also suggested central banks use the carbon budget approach for their own collateral management. It would be a way for them to reduce their climate risks and at the same time spread net-zero commitments within the financial sector.

Still, Samama flagged challenges in the proposal. Carbon budgets will shrink (particularly if warming speeds up) and change over time.

Some delegates raised concerns that the methodology would encourage investors to drop high emitters regardless of these companies’ emission pathway. Others said it would help investors own portfolio targets, but not help reduce wider emissions.