Portfolio alignment indicators: investor skepticism
Portfolio alignment is a hot topic and a key area of interest for the TCFD and COP26 private finance team. But what does this really tell us and how will it influence investment decisions?
The Task Force on Climate-related Financial Disclosures (TCFD) took a closer look at the use of forward-looking climate measures by financial markets. Following a recent consultation process, proposals include amending the TCFD 2017 guidelines to recommend for the first time that asset owners measure and disclose the alignment of their portfolios with the goals of the Paris Agreement. using forward-looking measures.
This sparked concern in the industry according to panelists speaking at Sustainability in Practice. While many investors support the principle of portfolio alignment, they argue that measuring and implementing such alignment remains a work in progress. In addition, adopting portfolio alignment measures could have undesirable consequences for asset owners regarding fiduciary obligations and costs and trigger divestment rather than commitment.
Aligning the portfolio with net zero goals is an area of growing interest for the investment industry, said panelist Eva Cairns, head of climate change strategy at Aberdeen. For asset managers, portfolio alignment now informs decisions as investors seek transition leaders and climate solutions.
However, she pointed out that portfolio alignment may keep investors away from investing in companies that may still be carbon intensive but are on track to reduce those emissions.
“Investing in companies with very strong industry leading targets has more impact,” she said.
In addition, she said alignment measures still pose challenges regarding data and regional differences, comparability and transparency.
She stressed the importance of observing the decarbonization trajectories of different sectors in different regions and the need for an active research approach that relies on broader inputs and a scoring methodology rather than a single measurement of temperature.
Adam Matthews, co-chair of the Transition Pathway Initiative and director of ethics and engagement at the Church of England Pensions Board pointed out similar concerns, especially given the TCFD’s influence on strategy pension funds.
He said temperature-aligned measures will become credible and decision-making, and will play a role. However, pension funds are currently unable to make meaningful use of these measures. Like Cairns, he warned that the measures could spur actions such as “removing assets” from portfolios, as opposed to responsible investing which means holding tough assets and working with companies on credible transition paths.
When investors aggregate a single metric across an entire portfolio, they run the risk of questionable indications that spur bad actions and unintended consequences.
“We want to do it right,” he said.
Panelist Dominic Tighe, political advisor at the COP26 Private Finance Hub, involved in the development of the TCFD’s proposals and consultation process, as well as in the best practice framework expected in October before the COP, defended the process. He noted the demand from asset owners for forward-looking measures that measure company ambition and distinguish between leaders and laggards within sectors.
He said the TCFD consultation was only a first step in ensuring consistency of methodology in these measures to reduce discrepancies in results. He also said that asset owners and investors don’t have to use a single metric or warming score, and the TCFD describes different tools.
He reiterated that what matters most is not whether an asset is high or low carbon, but whether the asset is changing fast enough. He noted that TCFD was aware of the risk of divestment and said the methodology made it clear that benchmarks should take into account different sectors and geographies, allowing investors to boost engagement and tilt portfolios.
Tighe reassured that the portfolio alignment metric is evolving and said recommendations have been reframed since the consultation with a less mandatory tone and without specifying which tools to use.
Nonetheless, Matthews urged the TCFD to build confidence in the process and expressed concern over the feasibility of large funds using the measures.
“There are steps to take so that we can aggregate this information. “
He said asset owners must also fulfill their fiduciary duty and that increased dialogue with managers and standard setters like TCFD is essential.
Expectations of COP26
In the run-up to COP26 in Glasgow, Matthews expressed concern that political frameworks might not appear outside of the conference.
Although encouraged by the unprecedented attention to finance, he said the policy had to match or the process risked “stepping into a brick wall.”
He said pension funds are committed to reaching net zero, to engage with businesses, but it also depends on regulatory changes.
“There has to be a corresponding part around the policy,” he said.
Cairns also noted the lack of action and that zero commitments are not possible without a political framework.
“I would like to see the COP as a tipping point in the ambition of the financial sector on the path to net zero ambition,” Tighe concluded.