Endowment Exposure to Fossil-Fuel Production Less than Two Percent of Assets
Some 10 months after the University announced its 2050 “net-zero” goal for greenhouse-gas emissions associated with investments held in the endowment—timed for the fiftieth anniversary of Earth Day last April—Harvard Management Company (HMC) this afternoon issued its first periodic “Climate Report” to the community. Much of the report focuses on initial progress in the multiyear process of determining how to get data about greenhouse-gas emissions produced by companies in which the endowment is invested and ways to determine the “carbon footprint” of investment portfolios overall.
But HMC has also taken advantage of the periodic report to make a first, limited disclosure about the magnitude of current fossil-fuel holdings—a point of particular interest to student, faculty, and alumni advocates of divesting such assets (which the University declines to do). And today’s report suggests that HMC is appraising not only the climate-related risks to companies in which it might invest, but also the emerging investment opportunities arising from the urgent pursuit of the net-zero economy of the future.
According to the report, as of last June 30 (the end of fiscal year 2020), HMC had “no direct exposure to companies that explore for or develop further reserves of fossil fuels” (language that echoes the text of the resolution advocating divestment on which the Faculty of Arts and Sciences voted favorably in February 2020). In comparison, the report notes:
HMC has reduced its overall exposure to fossil fuels—including both direct commodity investments as well as indirect investments in companies that explore for or develop further reserves of fossil fuels held through dedicated externally managed funds—from approximately 11 percent of the portfolio at the end of fiscal year 2008 to less than 2 percent at the end of fiscal year 2020, a decrease of more than 80 percent. These calculations reflect those exposures we can determine through available data.
That last caveat perhaps reflects the very different portfolio strategy HMC pursued in fiscal 2008, when the General Investment Account (which includes endowment assets), then totaling about $43 billion, held $4.2 billion in “liquid commodities” as a part of its $10.3 billion in “real assets.” Given the $36.9 billion value of the endowment at fiscal year-end 2008 (the peak valuation before the Great Recession and market crash that followed), the 11 percent may represent about $4.1 billion in such fossil-fuel investments and commodities; details of any holdings then in the multibillion-dollar equity, fixed-income, and hedge-fund portfolios may no longer be available or difficult to sort out. In any event, the current holdings related to fossil-fuel exploration and development, as of the end of fiscal 2020—2 percent of $41.9 billion—are in the range of $800 million: down by the 80 percent or so HMC reported today.
Getting the Data
HMC has had an ambitious agenda as it has pursued a multiyear reorganization, downsizing of staff, and implementation of new investment strategies and processes. In January, Narv Narvekar, CEO, announced that that transition, scheduled to take five years, has now been completed, more than a year ahead of schedule. It is in that context that the organization is focusing on the new University mandate to work toward a net-zero endowment by 2050. When the plan was unveiled last April, HMC indicated that realizing its goal would require collaborating closely with external fund managers “to achieve the necessary portfolio transparency,” as well as collecting data and creating methods to generate “the most accurate picture of the endowment’s carbon footprint.” Determining a methodology to assess portfolio emissions; applying it across the universe of investment managers; engaging them and the underlying companies in which they invest to mitigate climate-change risks; and, ultimately, reducing GHG emissions “will take extensive study, thoughtful deliberation…and, most importantly, time.”
In reporting today, HMC emphasized anew that “Our current focus and our priorities for the next few years” will revolve around “improving data access” and “developing a methodology”—and began to detail exactly what that entails. The work falls under Kate Murtagh, HMC’s chief compliance officer and managing director of sustainable investing, who oversees the integration of environmental, social, and governance assessments with investment decision-making. Much of that activity, too, focuses on acquiring data—in this case involving information on: portfolio enterprises’ baseline greenhouse-gas emissions, what steps they are taking to get to net-zero emissions, and how investors harness that information in assembling their holdings.
Even as that work begins, the disclosure of fossil-fuel holdings in 2008 and 2020 suggests that changes in HMC’s strategies and decisions, and companies’ climate-related adaptations during the past decade, have already had the effect of reducing investments in fossil-fuel-related assets substantially. But the deliberate pursuit of a net-zero endowment is something altogether different, requiring changes in business and consumer behavior (energy production and use), technology, public policy—and asset mangers’ ability to determine how those changes unfold, and to make their investing decisions accordingly. As The New York Times reported earlier this week, companies and asset managers alike are finding it far from easy to quantify their climate impacts and risks, set and effect strategies to reduce their carbon releases, and monitor their gains.
A highly diversified endowment, like Harvard’s, raises diverse data challenges, for many of which there are as yet no known solutions. HMC is invested across classes of assets, the broad spectrum of industries, in diverse geographies—and has committed itself to assess the greenhouse-gas emissions from the supply and demand sides of the economy. Among the problems HMC now must overcome are these:
• Getting information from external managers. HMC relies almost exclusively on external fund managers, rather than investing directly—and “like all limited partners in such funds, is not involved in the day-to-day operations of the funds and their underlying assets,” as today’s report notes. So it has to overcome that hurdle to get a better picture of “the underlying holdings data of its portfolio.”
• Assessing private assets. Compounding matters, the best information available pertains to large, public companies, whose climate-risk assessments and emissions data are relatively accessible. But such equity investments make up a small fraction of HMC’s holdings (see the distribution of assets for fiscal 2020 here). Information is much less well developed for private-equity investments, for example, and the filter resulting from external management of such assets compounds the problem of assembling a picture of portfolio investments’ greenhouse-gas emissions and climate-change strategies. HMC, the report says, is assessing approaches such as partnering with “third-party aggregators to collect the data from external managers and perform the analysis.” Over time, the report continues, “We are confident that external managers of both public and private markets will evolve their practices….Gaining the collaboration of other major institutional investors will be critical with regards to” investment managers for both public and private markets.
As an initial step toward estimating a “baseline carbon footprint of the endowment,” HMC has subscribed to emissions data available through three leading data providers—apparently MSCI, Trucost (a part of S&P Global), and ISS (Institutional Shareholder Services).
But as today’s report makes clear, the work is at a very nascent stage. It observes that:
[T]he process for calculating portfolio emissions has limitations due to the different methodologies companies use to calculate emissions, incomplete reporting by some companies, and the resulting use of partial company data to extrapolate or estimate historical emissions based on sector emissions performance. This process requires a large number of assumptions and decisions, which can potentially lead to inconsistent results when analyzing the same underlying data. For example, the data providers have different methods of aggregating GHG [greenhouse-gas] emissions from disparate sources (i.e., direct reporting versus estimates based on industry averages) and when combining portfolios of debt and equity securities.
The problem becomes still more complex when the assets are hedge-fund investments (more than one-third of HMC’s holdings as of last June 30). Compared to relatively long-term holdings in other classes, such strategies
…include long/short equity funds, high-frequency trading, the use of complex derivatives, and shorting of securities. No industry consensus currently exists on the best way to calculate the emissions of investments by these uncorrelated hedge-fund strategies and existing protocols are expected to continue to evolve over time. HMC is studying the underlying logic of existing protocols and we will likely adapt these protocols for the purpose of our own unique reporting.
Thus, even as it continues to “deepen its understanding of the methodologies used by the key vendors,” HMC will “conduct some basic analyses, which will likely improve our perspective significantly”—and will likely discover new questions along the way. The field is evolving rapidly: there are now alliances for net-zero asset owners and asset managers, and conversations are under way with other institutions that are interested in learning about HMC’s novel net-zero pledge.
In other words, this is very much an R&D operation, aiming toward the long-term goal of a net-zero portfolio. As today’s report puts it, “We are working aggressively to conduct a comprehensive assessment of the GHG emissions of investments in the portfolio. The timeline for when we will be able to do this will depend on how quickly our managers are willing and able to supply the necessary underlying data. We expect this process to take several years.” Along the way, HMC will continue to make periodic reports; will aim to establish and publicize its interim goals along the road to 2050; and, no doubt, iterate and refine its data analytics, methodologies, and findings about the portfolio’s aggregate greenhouse-gas emissions.
The Rising Decarbonized Economy, and Emissions Metrics
As part of the net-zero program, HMC joined the Task Force on Climate-Related Financial Disclosures (TCFD). Although the TCFD guidelines are aimed at corporate reporting, they are being used and applied by asset owners. In an appendix to today’s report, HMC makes an initial accounting of its organization and operations in the TCFD format. Two matters of interest arise from that process.
• New investment opportunities. HMC is at pains to describe climate change as presenting not only serious risks to businesses’ operations—risks that investors must now account for carefully—but also “enormous investment opportunities that translate into economic growth and job creation across industries.” Indeed, “Recent research suggests that transitioning to a low-carbon sustainable economy could deliver significant net economic gains compared to business as usual.” Among those HMC cites are opportunities in “energy storage, energy efficiency, renewable power, industrial/commercial redesign and retrofit projects, electrification across sectors, and water treatment, distribution and efficiency.”
Of late, the report continues, “HMC has seen an increasing number of investment opportunities from high-quality managers seeking to capitalize on these climate-related opportunities. These include investments in renewable power, biomass energy, materials technology, and water treatment. We will continue to evaluate and invest in such opportunities in the future.
• Metrics for measuring greenhouse-gas emissions. Given its assets, HMC expects to adopt an analytical approach tailored to its investment program. Nonetheless, consistent with the TCFD framework, “We expect to eventually calculate and disclose exposure to carbon emissions” using the task force’s indicators:
Carbon emissions — A normalized measure (by $M [million] invested) of the portfolio’s exposure to activities producing GHG emissions.
Total carbon emissions — Measures the carbon footprint of the portfolio (in tons of carbon dioxide). This metric has limited use for comparison to other portfolios because it is not normalized by portfolio size. It is calculated using an ownership methodology.
Carbon intensity — Expresses the carbon efficiency of the portfolio (by $M sales). Because this measure adjusts for company size, it is a more accurate measurement of efficiency than a portfolio’s absolute footprint. It is calculated using an ownership methodology.
Weighted-average carbon intensity (WACI) — Measures a portfolio’s exposure to carbon-intensive companies and indicates the potential climate change-related risks relative to other portfolios or a benchmark. It is useful for comparing portfolios across asset classes.
The hard part, of course is doing all the intervening work to be able to put those metrics into practice in HMC’s future investment decision-making. But the work has clearly begun.