The Importance of Decarbonizing Private Credit Portfolios: Balancing Sustainability Goals and Financial Returns

The decarbonization of a private credit portfolio refers to the process of reduce or eliminate portfolio exposure to investments or assets linked to carbon emissions or companies that are not aligned with sustainability goals and fight against climate change. This is how they maintain it Michael Curtis, Chief Strategy Officer, Private Credit, Camille McLeod-Salmon, Portfolio Manager y Glenn Oliver Anderson, Associate Director of Sustainable Investment Strategy.

With more capital flowing into private markets, ignoring their carbon footprint could leave investors vulnerable when it comes to balancing their decarbonization ambitions and risk-adjusted financial returns to meet the goals of the Paris Agreement.

Somehow, climate risk management in private credit portfolios is more crucial for lendersgiven typically longer holding periods, liquidity constraints and more complex exit strategies.

Besides, financial incentives are likely to increaseincluding regulatory requirements for private emitters to reduce emissions. As investors commit to decarbonization goals for their portfolios, they will need to extend decarbonization efforts to private assets.

The decarbonization cycle of private credit

However, the task can also be more complex. Private credit issuers tend to be smaller companies than their public market counterparts. The former have limited resources to improve environmental standards. An example is the measurement of operational carbon footprint, usually publicly available when investing in publicly traded companies. The same data is often unavailable, incomplete, or inconsistent with international standards for private corporate issuers. This lack of data may make it difficult for private issuers and lenders to gauge climate risks.integrate them into decision-making and measure progress.

For investors to address this data gap on their decarbonization path, Fidelity analyzes this and other challenges when it comes to reducing portfolio emissions in private creditexamining them in the context of specific asset classes, including collateralized loan obligations (CLOs), leveraged loans, and direct loans.