Utilising estimates about Scope 3 emissions could result in portfolios that are biased towards low-revenue companies, research by Osmosis Investment Management suggests.
In a paper, The Obstructive Role of Scope 3 Emissions Data in Portfolio Construction, the firm indicated that Scope 3 data – the emissions from the supply chain of companies required to report emissions – leads to portfolios with unappealing investment characteristics and are “irresponsible” on financial and environmental grounds.
The EU is mulling obligatory Scope 3 data integration into future Paris-Aligned Benchmark policies, but Osmosis said there is some way to go to ensure the reliability and usefulness of the data.
Scope 3 emissions account for around 90% of a company’s overall emissions across the entirety of its value chain and are of growing interest to regulators and investors alike.
However, a combination of poor disclosure rates, lacklustre data quality and growing market demands have resulted in major data providers, such as Bloomberg and MSCI, using revenue-based models in their in-house estimation processes.
But these approaches are flawed, the whitepaper argues.
Osmosis illustrated this with an example of two clothing manufacturers, one using cotton shipped halfway across the world, the other using sustainably sourced materials. If both companies make the same revenue each year, then, using revenue-based estimation, both companies will receive the same Scope 3 ‘score’, according to the research.
The whitepaper stated: “From an environmental perspective, using estimated Scope 3 data is nigh-on meaningless.”
On a live-fund basis, Osmosis analysed BlackRock’s iShares MSCI World Paris-Aligned Climate Fund. The data showed that using an estimation-based methodology and after adjusting for size, portfolios minimising scope emissions were also minimising revenue.
In practice, portfolios optimised to limit a Scope 3 footprint steer investors towards companies with low relative revenues and a higher-than-expected share price, the research found.
The paper stated that using revenue-based methodology to estimate Scope 3 data in portfolio construction is “misguided” and any claimed environmental benefits are “unfounded, and from a financial perspective, we would argue it is irresponsible”.
Currently, estimations from data houses do not correlate with self-reported values, Osmosis said. Not a single reported datapoint from MSCI World matched its estimated value from MSCI’s estimated Scope 3 dataset.
The London-based investment manager said investors should not consider evaluating company performance on Scope 3 data if it is considered immaterial or outside of management’s control. To overcome the issues raised in the report, a more granular approach to data is needed alongside further research, the paper noted.
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