Events | 23 May 2023

The Next Generation of Green and Sustainable Investing at GMO


GMO recognizes clients are at various stages of their climate change journey, ranging from measuring emissions data to setting targets for managing investment portfolios. Effectively managing portfolio carbon transition risk and capitalizing on climate change opportunities presents a challenging endeavor to investors. GMO has devoted significant time and resources into developing a holistic approach that seeks to successfully navigate through the economic transition to net zero by maximizing climate opportunities, while minimizing all scopes of emissions and severe ESG risk. Here we provide a detailed summary of GMO’s discussion of our research and Green Revenues strategy. Please contact your GMO relationship manager for a replay of the event or for additional information.

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Event Summary

Scope 3 and Indirect Emissions 1

When considering carbon transition risk of companies, it is important to understand emissions exposure across the entire end-to-end value chains, meaning scope 3, to identify hidden climate risks.

In our research, we found a major problem with reported scope 3 data, given how investors need to use the data. To promote increased reporting of scope 3, the Greenhouse Gas (GHG) Protocol provides companies with significant optionality in how they choose to estimate and report their own scope 3. This results in inconsistent estimation methodologies, which consequently means that reported scope 3 data is not comparable across companies. This issue is explicitly mentioned in the scope 3 standard, and presents a crucial problem to asset managers as managers need comparable data as we assess company carbon footprints during portfolio construction and aggregate exposures across our portfolios.

GMO’s solution was to go back to first principles and not use reported scope 3 data anywhere in the GMO Indirect Emissions model. We know that a company’s indirect emissions are someone else’s direct emissions, so we created a novel methodology that allows us to estimate indirect emissions for all companies in our model universe from the bottom up using the underlying direct emissions (scope 1 and household emissions).

By directly incorporating bottom-up data into a company supply chain model, we allow companies to distinguish themselves from their peers based on characteristics of their specific value chains. We then propagate direct scope 1 and household emissions through the supply chain model to calculate indirect emissions across end-to-end value chains. This is how we calculate indirect emissions from the bottom up and avoid using reported scope 3 data.

Emissions accounting across company value chains

The Next Generation of Green and Sustainable Investing at GMO_Exhibit 1_5-23.JPG

One of the most distinguishing aspects of our approach is that we are able to trace all indirect emissions back to their origins, meaning our model provides complete transparency and attribution of indirect emissions down to the company level. Our attribution analysis also indicates that we are likely capturing emissions exposures that are being missed by other vendors, especially across upstream value chains. Overall, we find indirect emissions account for 82% of total company carbon footprints, which is about 4.5 times larger than that of scope 1.

The GMO Indirect Emissions model ensures our estimates are comparable across companies because we consistently count emissions for all companies using the same methodology. This solution provides GMO and our clients with a more comprehensive and transparent view of carbon transition risk across portfolios.

GMO Green Revenues Strategy

The GMO Green Revenues strategy provides investors with a balanced exposure to climate opportunities while effectively managing the associated risks. Designed as a core component of a sustainable program, this strategy aims to deliver a return experience similar to the underlying investment universe (MSCI ACWI), while targeting climate opportunities, managing ESG risk, and optimizing direct and indirect emissions efficiency. This solution leverages GMO’s deep knowledge in portfolio construction and ESG integration to construct a style-neutral and diversified portfolio, setting it apart from other climate-themed products in the market.

Our portfolio construction process uses the following inputs:

  • Climate opportunities - by investing in companies that generate green revenue according to the FTSE Russell Green Revenue dataset, our process ensures the portfolio has exposure to at least 40% green revenue.
  • Scope 1 (Direct) & GMO Indirect Emissions – using the proprietary dataset we have created for indirect emissions alongside scope 1 emissions, we optimize portfolio-level carbon efficiency.
  • ESG risks – we capitalize on GMO’s proprietary ESG model to limit exposure to risks under the E, S, and G pillars that might affect the future profitability of firms. In addition, we exclude companies flagged with “severe” or “very severe” controversies in the MSCI Controversies dataset, with the aim of ensuring companies “do no significant harm” in the pursuit of green revenues.
  • Finally, we introduce country, sector, and beta constraints to neutralize style biases.

By design, the resulting backtested portfolio characteristics are:

  • Financed green revenue of approximately twice that of MSCI ACWI
  • Carbon efficiency of approximately 65-80% less than MSCI ACWI (considering both scope 1 and GMO Indirect Emissions)
  • High active share but a low tracking error
  • Style neutrality

Backtest Results

The Next Generation of Green and Sustainable Investing at GMO_Exhibit 2_5-23.JPG

*Backtest starts on 2015-03 with $1B cash and ends on 2022-12.  Portfolio returns are net of fees assuming a constant fee of 20 bps per year.  Benchmark is MSCI ACWI.  Statistics are annualized, except Names and Active Share, which are averages.  Past performance, whether backtested or actual, is no guarantee of future results. Please see important disclosures at the end of this presentation.
**Green sectors are based on the FTSE Russell Green Revenue Classification System.

While the portfolio is designed as a thematic standalone offering, we think asset owners can use this portfolio as their core holding in their sustainable program and tilt toward a particular style by other means based on their views.


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What are Scope 1, 2, and 3 emissions?
Scope 1: Direct Greenhouse Gas (GHG) emissions from operations owned or controlled by an organization.
Scope 2: Indirect GHG emissions from the generation of electricity purchased and consumed by an organization.
Scope 3: Indirect GHG emissions from sources and activities within the value chain of an organization that are not owned or controlled by that organization.

This presentation has been provided to you by Grantham, Mayo, Van Otterloo & Co. LLC (“GMO”) for illustrative purposes only, is intended exclusively for the use of the person to whom it has been delivered by GMO, and is not to be reproduced or redistributed to any other person. Nothing contained herein constitutes investment, legal, tax, regulatory, accounting or other advice of any kind nor is it to be relied on in making an investment or other decision. This presentation should not be viewed as a current or past recommendation or a solicitation of an offer to buy or sell any securities or to adopt any investment strategy. The investment strategy and themes discussed herein may be unsuitable for investors depending on their specific investment objectives and financial situation.

The information in this presentation is only as current as the date indicated, and may be superseded by subsequent market events or for other reasons. The information in this presentation has been developed internally and/or obtained from sources believed to be reliable; however, GMO does not guarantee the accuracy, adequacy or completeness of such information. The information contained herein may be based on (i) data that may no longer be current, (ii) estimates that may involve highly subjective assessments and (iii) models that may change from time to time and be different from the assumptions and models used by other persons.  Such information should not be the basis for determining the value of any security or financial instrument or in making any decision to buy, sell or hold a security or financial instrument. It should not be assumed that GMO will make investment recommendations in the future that are consistent with the views expressed herein, or use any or all of the techniques or methods of analysis described herein in managing client accounts.
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