Carbon Investing: How can we identify Greening Stocks?

The Global Sustainable Investment Review suggests that sustainable investments now represent as much as one third of all professionally managed assets in some developed markets. Carbon is the most widely discussed theme within sustainability. As a continuation of our work on systematic carbon investment strategies (previous report: Carbon investing: does a lower carbon intensity portfolio sacrifice return?), we identify companies that are more likely to reduce their carbon intensity in the future.

Identifying companies that will reduce their carbon intensity is difficult. Transparent, consistent and comparable data on companies' future plans to reduce carbon intensity is not yet available for a broad universe. Historic trend in carbon intensity is not predictive for future changes. We take a different (more indirect) approach. On the assumption that shareholders may influence companies to improve their carbon policies, we use data on institutions’ holdings to estimate each institution’s demand for green assets. Then we look at a company’s ownership. If its shareholders are mostly buy & hold institutions with a strong preference for low carbon intensity assets then they may influence the company to become “greener”. Companies in the top quintile by greening influence from institutional shareholders in 2015 were statistically more likely to have reduced their carbon intensity over the next five years. The median reduction in carbon intensity from firms with a strong greening influence from shareholders was 18%, compared to just 8% from firms with a weak greening influence from shareholders.

A sector and region neutral portfolio of the companies with the strongest greening influence from their shareholders would have outperformed by an average of 40 basis points per year with an Information Ratio of +0.38. This suggests that investors can tilt their portfolios towards stocks that are more likely to improve their carbon intensity (or screen out stocks which are less likely) without losing alpha.

We have analysed the institutional ownership for a global universe of stocks and identified 25 companies whose shareholders have a strong preference for low carbon assets and may influence these companies to reduce their carbon intensities in the future. Similarly, we have also run some regional screens and identified 22 companies from each of six regions. These screens may interest investors looking for companies that appear more likely to improve their carbon intensity ratios in the future.