Assessing carbon beta risk in portfolios: Platypus Asset Management

Measuring a portfolio's carbon emissions to produce a footprint is a blunt instrument that may not accurately measure and manage climate risk, according to Platypus Asset Management.

Platypus Asset Management has developed a quantitative tool aimed at measuring a company's sensitivity to climate change shocks, which they call the Platypus Carbon Beta.

Platypus Asset Management views ESG as a driver of investment return or alpha, said Platypus head of ESG and engagement Kristen Le Mesurier, who joined the firm in October 2020 from AMP Capital.

As such, they seek to analyse climate change risk and opportunity and how it impacts on the firm's high conviction, concentrated growth portfolio management process.

The Carbon Beta tool is designed to isolate the part of a company's share price that is purely related to its carbon profile, such that the portfolio analysts can measure an individual company's sensitivity to climate change shocks, said portfolio manager, quantitative investments Gareth Hurst.

"If you're running a portfolio and you say that, well, I'm going to exclude stocks based on the amount of carbon they're producing or their carbon intensity, what you're doing is not necessarily quantifying the risk, you're categorising it," Hurst said. "The way I see carbon risk is like a spectrum - low risk rising to high risk, and the question should be, what risk am I prepared to tolerate? If you're going to say that, you need to have a way to quantify that risk."

According to Platypus, the higher a company's sensitivity to carbon - what they call the carbon beta - the higher the risk of re-pricing by the market as the transition to a low-carbon global economy gains pace. The lower the sensitivity or beta, the lower the risk of re-pricing on purely carbon related grounds.

"What we're aiming to do with this tool is to say, we have market risk and what we're trying to do is isolate the part of the return that's due to carbon and not due to anything else," Hurst said. "What we do is, we take the returns of each stock, then isolate the part of the returns that are driven by the total carbon emissions. Effectively we control for other quant factors that are known to drive stock returns."

This risk approach allows for a more nuanced view in Platypus' view, Le Mesurier said. Platypus noted in a research note to clients that excluding companies that are currently emitting high levels of carbon misses the potential for companies to transition in the short to medium term and be rewarded for those efforts.

"Setting a carbon reduction footprint target is a blunt instrument and isn't going to help the portfolio navigate to net zero," she said. "It's a step in the right direction but how does a relative intensity carbon footprint align with a goal of absolute emissions reductions of 95% or more by 2050?

"Nor do carbon footprint targets necessarily deliver a lower risk portfolio. We can easily implement that - all it requires is excluding a handful of the largest emitters - but that's not the answer in itself."

Platypus is currently using the carbon beta tool as a tool for engagement with companies in its existing portfolio.

"The reason I was so excited to learn about this is that I've been frustrated over time by the focus on carbon footprints and reduction targets as the answer to addressing climate risk in portfolios," Le Mesurier said. "That approach leads to setting targets of, say, 20% less carbon intensity than the ASX200, with the assumption that this cuts out the high carbon footprint companies and leads to a lower risk portfolio.

"Emissions intensity targets won't necessarily result in a portfolio that's positioned for the transition and net zero by 2050."

Read more: Platypus Asset ManagementESGPlatypus Carbon BetaGareth HurstKristen Le Mesurier