Fjärde AP-fonden (AP4) is working on a project to incorporate companies’ indirect carbon emissions into its asset allocation decisions.
The Swedish pension fund is tackling the controversial area as part of its commitment to halve the emissions of its investments by the end of the decade, compared with 2020 levels.
It intends to align its entire portfolio with net zero by 2040.
Speaking to IPE, Pontus Lidbrink, who oversees AP4’s listed equity portfolios, explained that the fund already assesses companies on their temperature trajectory and the impact a carbon price would have on their future financial performance, using in-house methodologies and data.
It is now planning to add information about the emissions generated within companies’ supply chains and through the use of their goods and services, referred to collectively as Scope 3, into its methodology.
AP4 has already integrated data points relating to the emissions of businesses with whom portfolio companies have a direct relationship, such as major suppliers; but Lidbrink said expanding its Scope 3 coverage further was more challenging.
The topic has become a key battleground for investors, companies and regulators over the past two years.
It is difficult to collect accurate Scope 3 data, because of how vast and complex many companies’ value chains are, and because there is a risk of ‘double counting’, which can happen when the same emissions are attributed to multiple entities.
Earlier this year, the US Securities and Exchange Commission (SEC) rowed back on plans to ask companies to disclose their Scope 3 emissions, following pressure from corporates.
The European Union, on the other hand, requires companies covered by the new Corporate Sustainability Reporting Directive to be transparent about such emissions.
“It’s going to be a lot of work to incorporate Scope 3 data, and it has raised a lot of portfolio-construction questions,” said Lidbrink. “We need to do this in a way that continues to enable our portfolio managers to believe in the strategies they’re running – it can’t just be for show.”
He added that one of the main challenges for a pension fund like AP4 was the impact that the inclusion of Scope 3 data would have on its ability to invest in the finance sector.
“If you just overlay a scope three data set across the whole portfolio, it will impact financials the most, and that requires a lot of thought.”
Lidbrink described financial companies, such as banks, as having had “a bit of a free pass” in low-carbon portfolios so far, despite the fact they have high exposure to carbon through their lending, underwriting and investment activities, because those activities are not captured by Scope 1 and 2 data.
To incorporate Scope 3 data in a way that continued to enable sound portfolio construction, Lidbrink suggested AP4 may develop a sector-neutral approach, meaning companies would be compared to peers within their own sector – instead of being assessed at portfolio level – and the best performers within each sector would be overweight.
“We think this is a better way of incorporating Scope 3, which more adequately captures sustainability risks and tilts the portfolio towards future green leaders,” he said.
AP4 plans to have completed the project and be incorporating Scope 3 emissions data into its asset allocation by next year.
Read the digital edition of IPE’s latest magazine
No comments yet