It couldn’t have been any simpler. Fulcrum Asset Management wanted to count the carbon emitted by its business, which consists of two office buildings—one in New York and one in London. The hedge fund asked several firms to provide it with an answer. They came back with “quite different outcomes”, says Nabeel Abdoula, the fund’s deputy chief investment officer, because they used different methodologies, assumptions and warming scenarios.

Fulcrum picked Iceberg Data Lab, a French company backed by a consortium of European asset managers, including insurance company Axa. Iceberg’s model creates an implied temperature rise score, a number expressed in degrees Celsius of warming that a security or portfolio is on track to produce.

The hedge fund industry, along with much of finance, is swept up in the effort to limit its greenhouse gas emissions, most of which come from the companies it finances by holding their stocks, bonds and loans. Company emissions boil down to one temperature reading—the amount the world would warm if the rest of the economy generated greenhouse gases at the same intensity as the company in question. If a reading is greater than 2°C, a company needs to change its strategy to comply with the Paris Agreement, which aims to limit global warming to “well below 2°C”.

In its 2021 buy-side risk survey, Risk.net, a sibling publication of WatersTechnology, finds that while 63% of firms have set targets to reduce their portfolios’ carbon intensity, many have stalled at implementing cuts. And while most firms began to reduce the carbon intensity of their portfolios in 2019 or before, more than 20% haven’t kicked off at all, or say they plan to later this year.

But without a clear picture of the emissions produced by the companies they invest in, it is difficult to institute a plan, say asset managers.

Their biggest problem is the data. While 55% track Scope 3 emissions—the carbon emitted by the companies they own—the vast majority, a whopping 97%, can only do this for less than 60% of their assets under management.

Consequently, some 50% of firms are currently unable to calculate the carbon intensity of their portfolios—let alone reduce it.   

This is a problem. According to analysis by MSCI, funds that began making emissions cuts last year will need to reduce their carbon intensity by 7% annually to achieve net zero by 2050, while those that put them off until 2025 will need to make double these annual cuts to achieve the same outcome.   

Meanwhile, pressure has also increased for asset managers to be more transparent. 

By 2025, UK and European regulators will require asset managers to report their Scope 1 and 2 emissions—or how much carbon they emit in the course of their business—in addition to their Scope 3 greenhouse gasses. 

The US Securities and Exchange Commission says it will decide near the end of this year, or at the start of 2022, whether it will do the same.  

And then there’s the problem itself—global warming.

A company needs to cut its share of emissions in half by 2030, according to the Intergovernmental Panel on Climate Change’s Special Report on Global Warming of 1.5°C, if the world is to avoid “irreversible loss of the most fragile ecosystems”.

Waci races

Asset managers say their efforts to reduce emissions are being hampered by a dearth of data on the one hand, and on the other by an abundance of competing metrics and methodologies for calculating their carbon footprints.

This month, the TCFD released new guidance intended to clarify the issue. Reluctant to abandon its objective stance as a voluntary organization, it picked one metric to “emphasize” rather than outright recommend: weighted average carbon intensity (Waci), expressed in carbon emissions (CO₂e) per $1 million of revenue.

Yet this is the least popular method for expressing carbon intensity, according to the survey, and is used by just 7.46% of respondents. The majority—54%—prefer to express carbon intensity in terms of CO₂e per $1 million invested, a metric the TCFD calls “carbon footprinting”, while 31% say they prefer to report total carbon emissions.

The TCFD’s own status report similarly found that Waci was used by just 8.1% of asset managers, making it the least popular of the main carbon metrics, behind total emissions, carbon footprinting and unweighted carbon intensity.  

All four of these metrics have the advantage of being transparent and relatively simple to calculate, with inputs limited to a company’s total emissions and its revenue or market capitalization.

“If you have a portfolio that’s emitting 150 tonnes of carbon per million of revenues today, and you can show that portfolio’s emissions are falling towards zero, we can have some confidence in that because it’s transparent,” says Craig Mackenzie, head of strategic asset allocation research at Aberdeen Standard Investments (Mackenzie is not related to the writer of this story).

A significant number of asset managers (52%) are also calculating a more complex metric, known as an implied temperature rating or score, which shows how much global warming a portfolio will cause over a period of time.  

Several large asset managers, including BlackRock, have committed to publishing temperature scores for funds that invest in markets with reliable climate data.   

Proponents of implied temperature rise say it is one of the few models that looks into the future rather than measuring past performance.

Bruno Bertocci, head of sustainable investing in active investing at UBS Asset Management, says that large asset management firms have been focused on implied temperature rise metrics and carbon intensity for quite some time and that this looks set to continue.

“I think take-up will accelerate because investors want it; the public wants it,” says Bertocci, adding that virtually all the top 20 asset management firms are already doing this. “You do need a bit of size,” he acknowledges.

Most other carbon metrics, by contrast, are based on a snapshot of a company’s emissions at a single point in time. Much of this data is self-reported and outdated: a company that publishes a climate report in 2021 is disclosing emissions from 2020.  

The survey reveals that asset managers are experimenting with several methodologies for calculating implied temperature ratings—MSCI’s Warming Potential, used by 40% of respondents, is the most popular.

Firms that calculate temperature ratings for their portfolios use 1.9 methodologies on average to do so, suggesting that no single approach ticks all boxes.

In its TCFD report, Fulcrum will disclose multiple metrics, including total emissions, carbon intensity and implied temperate scores. But it is using the latter to set internal targets. Today, 25% of Fulcrum’s portfolios are aligned with a 1.5°C global warming scenario, but the firm’s aim is to have all of its portfolios under 2°C within the next two years, well ahead of the targets set in the Paris Climate Agreement.  

Abdoula says the fund chose Iceberg because it was able to calculate the separate carbon trajectories of different sectors, in addition to producing a single temperature score at the overall portfolio level.

Others argue that implied temperature ratings are too much of a black box to be used to set targets. Adam Matthews, chief responsible investment officer for the Church of England Pensions Board, doesn’t believe the metric is an appropriate method for gauging an investor’s contribution to climate change—somewhat surprising, considering his employer co-founded the Transition Pathway Initiative, which has its own methodology for calculating the implied warming potential of investment portfolios.

Despite the fact that the TPI offers the metric, Matthews does not recommend it. 

“We get the objective of having implied temperature metrics, but at the moment we don’t think they’re credible,” says Matthews. “There is further work to be done before they are used by pension funds.”

The problem with implied temperature scores, according to Matthews, is that they look at a particular moment in a company’s efforts to “green” itself and extrapolate from there. This might paint a discouraging picture of companies that are trying to transition away from high-polluting activities. 

We get the objective of having implied temperature metrics, but at the moment we don’t think they’re credible

Adam Matthews, Church of England Pensions Board

Even environmentally ambitious projects might earn a poor temperature score at first, given how the method currently works. A wind farm, for example, might appear very carbon intensive at the outset because of the large amount of steel that would be used to construct it. 

A solution may be on the way. This month, the IFRS Foundation, which oversees the setting of global accounting standards, formed a new body to develop standards for sustainability disclosures. The International Sustainability Standards Board will commence work in early 2022 and could issue its first standards before year end.    

UBS’s Bertocci calls this a “very important” development. “If you go back far enough, there were no global accounting standards. The Financial Accounting Standards Board was a voluntary organization until the SEC said these are the standards,” he says. “I think you are going to see the same sort of thing that happened with accounting rules happen with climate data.”

‘No viable pathway’

The question of how to measure begs another thorny question: once an investor knows how much carbon is in its portfolio, how will it cut back?

“You can shift more capital into the low-carbon areas, you can invest in low-carbon infrastructure, for example, or real estate,” says Bruce Duguid, head of stewardship at Federated Hermes EOS, the shareholder relations service at the French asset manager. “Then, in the public markets, it’s a matter of stewardship of the assets or portfolio change.”

Investors that hold shares of energy companies—high polluters that might, with engagement, become greener—hesitate to finalize strategies in the hopes they might change their ways. 

Oil giant Shell gained shareholder support for its May climate strategy to slowly reduce its oil and gas output. On the same day, the International Energy Agency (IEA) said investors should freeze funding for new oil, gas and coal projects. How should an investor proceed in such a scenario? Engage or sell shares? 

But some decisions are more clear cut. Over a third of respondents to the survey said their firms have already excluded investments linked to coal, Arctic drilling and oil sands from their portfolios, while 17% said all fossil fuel investments were blacklisted. The sovereign debt of high-polluting countries is also out of bounds for 26% of respondents, while 12% are divesting from companies that do not disclose climate risks.

And the time for over-thinking these matters has passed, says Duguid. These decisions need to be made now, because the longer an investor delays, the more their options narrow. Waiting until the only choice is to divest from companies to meet regulatory requirements could cause financial instability. 

“I think that’s why a lot of investors would divest from coal now, because there’s no viable pathway for coal companies to easily transition. And you’ll see that beginning to happen in other asset classes where the viable pathway diminishes,” he says. 

Experts like Kirsten Snow Spalding, the senior program director of the Ceres Investor Network, a group of 200 industry members with a combined $32 trillion under management, says asset managers need to stop quibbling over the data and get a move on.

“These investors can say: ‘well, we don’t have enough data to know what’s going to happen in the portfolio’. But the real question is not, ‘what do you know?’ but, ‘what do you do?’,” she says. “Investors need to pull up their socks.”

She describes Ceres’s four-step plan: work out a climate-oriented investment policy, devise a strategy of how to manage it, speak with the companies they invest in and engage with policymakers. 

Some investors are engaging with companies and lobbying around the political expenditures. You can begin to see these sectors moving in the right direction

Kirsten Snow Spalding, Ceres Investor Network

“Policy change supports the shift,” says Spalding. If an asset manager is going to make public declarations about global warming, it also needs to talk to regulators and convince them to become part of the effort. 

“Some investors are engaging with companies and lobbying around the political expenditures. You can begin to see these sectors moving in the right direction,” she says.

Spalding notes how big passive funds like BlackRock and State Street have started to do this, but only on a portion of their portfolios. 

“They say, ‘well, you know, we’re client-driven, we don’t have a client mandate to align with net-zero for 95% of the assets—so we’re just going to start with the 5% that we actually have control over’.”

Her take is that you can’t be a net-zero asset manager if you’ve only applied it to a tiny percentage of your portfolio. “Be clear. Should you really get that credit if you’ve only got 5% covered?” 

This problem spans the industry, according to the survey findings. Carbon-reduction targets covered less than 50% of total assets under management at 90% of firms.

Pale green

So, if the $103 trillion asset management industry cannot overcome its data issues and its strategy obstacles, it might bottle its chance to keep the earth cool. 

But Céline Soubranne, Axa’s group chief sustainability officer, remains optimistic for her industry. 

The top-five insurer is headquartered in France, where disclosure on a company’s greenhouse gasses is mandatory. Axa published its first TCFD report in 2018; one of the first asset managers in the world to do this for Scope 3 emissions. 

Soubranne believes that investors that have delayed climate change strategies until this year will at least be able to capitalize on all of Axa’s trial-and-error experience up until now. 

“We’ve shared our experience,” she says. “This is why the coalitions we built are so important. Those with a sitting protocol, a common methodology and a common matrix.”

The real economy is not green enough—it’s tiny today. We are sometimes trapped by the fact that we can’t invest in enough projects

Céline Soubranne, Axa

But the industry has a lot of catching up to do. Of the asset managers that have set targets to reduce the carbon intensity of their portfolios, 21% have yet to begin making any cuts. Among those that have, 76% have achieved cuts of less than 3% to date—far less than the 7% annual reductions necessary to reach net zero by 2050—and 82% expect to register cuts of less than 3% in 2021.

Longer-term expectations are more optimistic, with 32% of respondents targeting emissions cuts of between 20-30% by 2030.   

While Axa has come a long way, Soubranne says it has also grappled with data reporting and brooded over strategy. 

To divest from a company that pollutes would starve it from the investment it would need to change, she says. She would also like to see better data to track companies on whether they make good on their energy transition promises. 

Even after overcoming these hurdles, the battle to forge ahead with a greener investment policy presents new challenges.

Soubranne recalls the moment recently when an employee asked why Axa doesn’t just increase its €25 billion ($ 28.6 billion) investment in green infrastructure. 

“The real economy is not green enough—it’s tiny today,” she says. “We are sometimes trapped by the fact that we can’t invest in enough projects.”

For Soubranne, there is no one innovation which will fix why asset managers struggle to disclose carbon emissions and make plans to limit them. They just have to get on with it, she says.

“There is no magic bullet. We have to use all of the levers.”

Additional reporting by Will Hadfield and Kris Devasabai