Low-carbon, high return. How to decarbonize your portfolio in 4 steps.

First and foremost, investors will need to understand the carbon exposure of their portfolio and to what degree the underlying companies are aligned with the goal of keeping warming within1.5°C or 2°C. The carbon footprint of a portfolio is the weighted average carbon emissions of the underlying companies in the portfolio and can be compared with a reference benchmark to give a rough estimate of the impact of the investments.

However, a company’s carbon emissions are only part of the story. As the economy transitions to a low carbon economy, some sectors, such as the supply chains for wind turbine and solar PV manufacture, generate significant emissions at the company level, yet are likely to benefit considerably from the climate transition. Therefore, it is also important to measure carbon transition preparedness to give a full picture.

Once an investor has assessed the portfolio for carbon exposure and identified companies that may face significant risks from a climate transition, they can start swapping out some of the laggard companies in exchange for lower-emitting or more climate-aligned securities. There are now low-carbon substitutes in almost all asset classes in a typical portfolio that can dramatically lower the carbon footprint while retaining a similar risk/return profile.

The climate transition will happen at varying paces. Different jurisdictions will increase the price of carbon at different times and rates. In addition, the effects of climate change and carbon prices will affect every company based on the particular circumstances of their set–up and business model: Therefore, climate risk assessment will need to be built into fundamental analysis of investments.

Simply shifting out of high emitters into climate-aligned companies, does not solve climate change. Investors need to direct capital towards solutions as well. However, companies and funds focused on those solutions are often at the higher-risk, higher-conviction end of the spectrum, and tend to be concentrated in a smaller number of sectors.

Currently they are often placed in a “satellite” allocation as opposed to the “core” portfolio. But as climate solutions become more mainstream and these companies grow in size and maturity, they will increasingly become part of investors’ core portfolios.

Our report, The decarbonizing portfolio, explains in depth why investor portfolios need to be ready for the inevitable shift to a low-carbon economy. Our research outlines various types of sustainable and impact investing approaches that can help investors prepare. It describes new methodologies to assess risk and opportunity from climate change, and discover steps investors can take to decarbonize their portfolio now to reap the benefits in the long run.

Investments can go down as well as up and your capital may be at risk

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