Investors may need all the tools at their disposal

Carbon-intensive companies saw a drop in their book value, or assets less liabilities, over the seven years that ended in March 2021. They saw their cost of capital rise over the same period.

Investors may want to use all the tools at their disposal to take climate change into account and align portfolios with the prospect of a net-zero economy. Allocating capital away from carbon-intensive companies, prodding those that delay emissions cuts and investing in green technology all can incentivize companies to reduce their carbon footprints, write MSCI’s Guido Giese, Zoltán Nagy and Chris Cote. The authors examined a series of approaches that investors can draw on to minimize climate risk and align portfolios with global temperature goals.

As a fourth option, investors may want to use their clout to push policymakers to put a price on carbon – a market failure that continues to let companies avoid their fair share of the cost of their carbon emissions, the report notes.

Humanity’s interest in averting the worst effects of a warming planet and the financial benefits of moving toward net-zero go together, say the authors, who note that decarbonization by companies also minimizes the costs of climate change for the global economy and investors, thereby aligning their interests.

“In other words, while the first question — how to take advantage of the climate revolution within a portfolio — is about creating ‘better alpha’ in an investor’s portfolio, the second question —shifting the real economy onto a net-zero path — is about creating a better ‘market beta,’ alongside better outcomes for humanity and the planet,” they write.

The book value of companies in the MSCI ACWI Investable Market Index (IMI) fell by nearly 4% over the period analyzed, while their cost of capital rose by roughly the same amount (see exhibit below). Both measures changed in relation to companies’ carbon intensity, as measured by their direct and indirect (Scopes 1 and 2) emissions, the analysis shows.

Shareholders are pressuring companies on climate change, albeit unevenly, the report notes. Climate-related shareholder proposals filed with U.S. energy companies over the roughly three years that ended last July garnered their highest rates of approval in 2020 and 2021. Yet the number of climate-related shareholder proposals filed with companies in the utilities industry, another carbon-intensive sector, fell during the same period.

The disparity suggests that investors have yet to use shareholder engagement at scale to drive decarbonization, according to the authors, who note that engagement with the largest greenhouse gas emitters shows investors can boost their leverage by banding together.

The report notes that companies targeted by coordinated campaigns have tended to see greater frequency of shareholder engagements on climate change. Between 2017 and 2021, 38 U.S. companies targeted by the investor-led Climate Action 100+ initiative reported an average of 8.3 climate-related shareholder proposals in their proxy statements. That compares with an average 3.9 climate proposals filed with the 506 U.S. companies that received at least one shareholder proposal in the same period.

Investors and society at large incur costs from the largest corporate emitters of carbon. With their outsized contribution to climate change, energy companies, for instance, contribute to future losses for insurance companies that will be required to pay for the damages of coastal flooding and other weather extremes.

To deter free riders, pension funds, sovereign wealth funds and other large institutional investors that own a share of the entire market can advocate for policies that put a price on carbon, according to the authors. California’s emissions-trading scheme, they note, has produced a price on carbon of about USD 200 per metric ton that ranks as among the highest in the world and fueled investment in renewable diesel that emits one-third of the carbon than the diesel it replaces.

“While it’s still too early to assess the impact of California’s fuel program on investments, it is clear that it has been an engine of innovation for U.S. transport fuel producers, providing incentives for companies to invest in low-carbon technologies and alternative fuels,” say the authors, who suggest that “engaging with governments on net-zero policies can be an important avenue to further investor goals, supporting net-zero convergence between portfolios and the economy.” These findings align with the recommendations of the Net-Zero Asset Owners Alliance that investors advocate for a global carbon pricing mechanism.

Net-Zero Alignment: Objectives and Strategic Approaches for Investors. An examination by MSCI ESG Research of three common approaches to net-zero investing to see whether they can have a real impact on decarbonizing the economy.