Decarbonization is top of mind for institutional investors all over the world. During the Inquire Europe spring seminar Philipp Krueger from the University of Geneva presented his research ‘Decarbonizing Institutional Investor Portfolios’, in which he discusses whether and how climate-conscious institutional investors, i.e., investors that support climate initiatives such as CDP or Climate Action 100+, are decarbonizing their equity portfolios. The paper also studies the interaction between investor-led climate initiatives and carbon pricing schemes in reducing corporate emissions.
For those who were unable to attend his presentation, a summary has been made:
“Tackling climate change and limiting global warming to well below 2 degrees Celsius is one of the biggest challenges we’ve ever faced; in essence, decarbonization on a massive scale is going to be required. In this research we focus on institutional investors, specifically on the decarbonization efforts they are pursuing in their equity portfolios. To do so, a series of big picture questions are asked.
Firstly, we want to find out whether in aggregate institutional investors are decarbonizing their public equity portfolios. Second, we zoom on climate conscious investors, institutional investors that join climate initiatives, and ask whether we observe that these types of investors decarbonize more than the average institutional investor. Given that there is no global carbon pricing scheme, we also ask how investor-led climate led climate initiatives interact with carbon pricing schemes by examining investors located in countries with active carbon pricing schemes in place. Specifically, we ask the question whether investors in these regions and jurisdictions decarbonize more or differently than investors located in places that do not have these sorts of legislations. Finally, we evaluate the strategies institutional investors employ to achieve decarbonization in their portfolios.
Regarding the first question, we find evidence that institutional investors as a whole have decarbonized their equity portfolios substantially over the sample period from 2004 to 2019. Secondly, climate investors decarbonize faster than institutional investors. The exact magnitude of the additional decarbonization depends somewhat on the chosen institutional investor carbon measure. For the third question, we find that portfolio decarbonization primarily happens in countries that have carbon pricing schemes in place. Climate conscious investors outside of these regions do not seem to decarbonize much. Exploring the different ways in which institutional investors achieve decarbonization in their portfolios, we observe that investors are primarily tilting away from high emitting firms and towards lower emitting ones. We also find some evidence of corporate changes, i.e., reductions in portfolio emissions resulting from changes in the firms’ underlying emissions, possibly driven by shareholder engagement. However, our research does not uncover systematic evidence of corporate changes, suggesting that decarbonization is achieved primarily through reweighting.
Given that institutional investors reduce their portfolio carbon emissions primarily through reweighting to lower emitting firms, our analysis raises doubts about the effectiveness of institutional investor led climate initiatives in helping reduce global greenhouse gas emissions. Institutions seem to be mostly “greening their portfolios” instead of “greening the planet” given that, in the absence of second order effects through higher cost of capital, reweighting doesn’t reduce the carbon emissions of the underlying firms. Institutional investors that decarbonize their equity holdings via portfolio re-weightings may just be pushing away the problem to other investor groups that might be even less motivated to tackle corporate carbon emissions. In other words, the negative externality of carbon emissions is not reduced though widespread reweighting. More research is needed to evaluate if there are second order effects on the cost of capital of firms resulting from reweighting, and if so, how big they are”.
Inquire Europe members can access the research and the presentation slides via: https://www.inquire-europe.org/event/joint-spring-seminar-2023/