Andy Howard: our approach to carbon offset share classes
As Schroders launches carbon offset share classes for a climate fund, our Global Head of Sustainable Investment explains what this means and why it matters.
The annual indirect emissions attributable to typical UK households’ financial savings and investments are of a similar magnitude to their direct emissions from conventional sources like heating and transport.
That investors are becoming increasingly focused on that indirect exposure is unsurprising. The direct emissions of global listed companies equates to around one third of global CO2 emissions.
The investment industry’s growing recognition of the climate threat is reflected in asset owners’ commitments to portfolio decarbonisation. Large institutional investors controlling assets of $11 trillion have joined the Net Zero Asset Owner alliance, equal to more than 40% of the total assets of the world’s 100 largest asset owners.
At Schroders, we are committed to transitioning the portfolios we manage toward the net zero goals the large majority of the world’s governments have now committed to. We continue to engage intensively with portfolio companies to encourage change.
The same focus is reflected in sustained demand for climate funds. Morningstar reported that globally, assets under management in climate-related mutual funds doubled in each year 2019-2020 and 2020-2021, with assets standing in excess of $400 billion as at December 2021. In addition, PwC’s State of Climate Tech Report noted that in 2022 more than one quarter of all venture capital funding went to climate technology, with increased focus on technologies that have the most potential to cut emissions.
Carbon offsets are no replacement for the significant change required from most companies to reduce their emissions. However, offsets can help accelerate progress toward the long-term global emissions reductions needed to avoid the worst effects of temperature rises.
We expect carbon offsets will be an important part of the solution to the global climate challenge and to investors’ transition strategies. The IPCC has outlined its expectation that negative emissions, or offsets, will play a much bigger role in meeting global decarbonisation goals in the future.
At Schroders, we have initially applied this share class to a fund focused on climate leaders. We have focused on a strategy that already emphasises companies transitioning quickly toward a low carbon economy.
How does a carbon offset share class work?
In this case, every quarter we will purchase carbon offsets equal to the emissions of portfolio companies attributable to the share class. For example, if the share class holds 1% of the emissions of a company, we will calculate 1/100th of that the company’s Scope 1 and 2 carbon emissions.
Adding together all of the equivalent exposures to carbon emissions yields an estimate of the total carbon emissions attributable to the share class. We will then purchase and cancel an equivalent volume of carbon offsets, taking those credits out of circulation and “locking in” their emissions benefit.
The cost of purchasing those emissions will be applied to the share class, so that its management fee is reset every quarter. In more volatile conditions, those calculations may be made monthly.
Based on the most recent calculations, the additional fee applied to the share class for the climate leaders fund in question will be 5.7 basis points (i.e. 0.057%). This figure equates to less than 5% of the current standard fee.
What are some of the challenges and how can we tackle them?
The emissions data companies report varies in timeliness, quality and consistency, while some companies do not yet report that data at all.
To provide transparency on fees, they are calculated at the start of each quarter and remain constant until the next review, irrespective of changes in portfolio holdings or companies’ emissions.
We use recognised third party data providers, with emissions estimated where they are not reported. By doing so, we aim to estimate the carbon emissions associated with the share class, recognising that this is necessarily imprecise.
The offsets bought on behalf of the share class do not represent an investment. They are cancelled when they are bought, so that investors in the share class will not benefit from rising carbon offset prices. Rather, they provide a way for investors to easily offset the emissions associated with their holding in the fund.
Carbon offsets have come under scrutiny in recent years. The quality and benefits of different types and sources of offset can vary significantly. Those differences are reflected in the wide range of prices for offsets, which can range from a few dollars per tonne of CO2 to several hundred.
At least initially, we will use offsets acquired to help Schroders meet our group commitment to carbon neutrality in our operations. Those offsets will come from a range of natural capital projects around the world which we consider high quality. Leveraging the group’s offset purchases also allows us to limit exposure to fluctuations in carbon prices.
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The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.