Expert discussion on the role of forward-looking climate metrics in decarbonization portfolios

Can you briefly explain what your paper is about and what the main results are?

Jieyan: The focus of the paper is on climate metrics that have a connection to the future emissions of companies. We analyse whether forward-looking climate metrics are suitable for identifying companies that are striving for sustainable transformation. An important result of the study is that companies with CO2 reduction targets or climate-friendly patents show lower growth in emissions in subsequent years than comparable companies without such climate targets. However, future- and past-oriented climate indicators can contradict each other – for example, companies with current high emissions tend to have more ambitious climate targets. We have also found that mutual funds are more focused on backward-looking climate indicators.

What was your motivation for writing the paper?

Frederik: ESG topics have been in the spotlight in recent years. At Quoniam, we have been looking at how best to implement ESG into the portfolio – and not just superficially, but by using a data-driven and science-based approach. We have noticed that the climate assessment of companies mainly looks at emissions from the past. It should also be considered how emissions will reduce in the future. A pure concentration of the portfolio on past emissions data excludes high-emission industries, but thus also potentially strong transformation candidates. After all, companies that have high emissions today must achieve their sustainable transformation in the near term. This question piqued our curiosity and we wanted to find out how to capture this transformation potential in the portfolio.

First, we wanted to generally understand the data and the correlation between the many metrics that exist in the ESG field. When we analysed the data, we noticed that green patents are partly correlated with CO2 emissions, i.e. companies with more green patents tend to have higher CO2 emissions. We found this interesting, which is why we deepened our analyses on this.

Has there been any other research on the topic of transformation potential and future-oriented climate data so far?

Frederik: Not directly on this yet. Most papers so far have focused on past data. One exception is the research by Cohen et al. (2021)ⁱ , who recognise in their paper the connection that companies with high emissions, e.g. energy companies, have a high number of environment-related patents. They question whether it is right to exclude such companies from the portfolio per se. In our paper, we explored this question further and looked at whether companies with good forward-looking metrics or climate targets actually reduce their emissions.

Jieyan, you recently presented your paper at the Frontiers of Factor Investing Conference at Lancaster University. How was the response?

Jieyan: Both financial practitioners and academics attended the conference and both sides received the paper with great interest. A research colleague from another asset manager told me that they would also like to study forward-looking data but are currently hesitant because there is no uniform regulatory guidance on this yet – and our paper was therefore particularly exciting to gain insight into this rather new topic. The conference participants from the academic world agreed and were also interested in our paper because, as I said earlier, there are not yet many findings regarding relevant research questions on forward-looking climate data.

Outside of such conferences, we are also in exchange with various universities, for example with Marco Wilkens’ Finance & Banking Chair at the University of Augsburg, which is very much engaged with the topic of climate. At the beginning of November, we will present the results of our paper to Professor Wilkens, doctoral students and postdocs of the chair and discuss them.

How does this topic fit into our ESG Research roadmap? Are you planning further analyses on the topic of ESG or climate?

Max: Yes, definitely because we are in the process of launching our new climate product Quoniam Equities Climate, the topic is gaining in importance. Regulation is also constantly evolving. As Jieyan mentioned, it is not yet completely clear what requirements will be placed on future-related ESG metrics by policymakers. The most important thing for us in research at the moment is to understand what data is available and how it can be used. Our affiliation with the Union Investment Group also helps us as we are constantly exchanging ideas with their experts on ESG matters.

We also continue to seek cooperation with the academic world. In the future, we would like to work with universities, for example, to examine forward-looking data sets in greater depth as part of joint research projects. For this purpose, we have taken on a new intern from December onwards, who will work on a promising data set in more detail for later analyses. As part of our Quoniam Doctoral Programme, we also plan to better understand potential links between asset pricing and ESG metrics.

One thing is certain: climate remains an important, exciting, but also fast-moving investment topic. And we are staying on the ball.

You can read the full working paper here:

Working Paper (SSRN)