Investing for Net Zero

Economies, businesses and investors around the globe are joining the UN Race to Zero and committing to net zero 2050 targets. It is estimated that reaching net zero 2050 will require around $1-2 trillion of investment every year¹. Investors therefore have a critical role to play in making net zero happen through their capital allocation and engagement activities.

At ASI, we are committed to playing a constructive role in the decarbonisation of the global economy and enabling our clients to reach their net zero goals. That’s why we have joined the Net Zero Asset Manager initiative. We are developing net zero solutions and will work with current and prospective clients to outline how net zero goals can be delivered alongside risk-adjusted returns. We also aim to increase the percentage of our AUM that is aligned with net zero over time in support of our clients’ aims and expectations.

What is needed to enable investing for net zero 2050? 

It is critical that the growing wave of net zero pledges is reflected in policies and actions to provide investors with certainty and the right incentives to enable capital allocation for net zero in the long term. Countries with net zero pledges represent nearly 70% of GDP and over 60% of global greenhouse gases², which is extremely encouraging. But unfortunately, we are far from being on track to meet net zero 2050 goals. The recent UN Emissions Gap report³ highlights that even if all current net zero pledges were implemented, we would still fall short of keeping warming to below 2°C. In addition, most country’s Nationally Determined Contributions (NDCs) to achieve the goals of the Paris agreement remain inadequate, as highlighted in the recent UN NDC Synthesis report⁴.  We need to see a significant step-change in policy commitments ahead of COP26 to send the right signals for net zero investing to businesses and investors.  

We think that investing in companies with ambitious and credible decarbonisation targets rather than divesting has a bigger impact on achieving net zero in the real world

What does investing for net zero really mean?

It is important to differentiate between achieving net zero in the real world versus a portfolio. Real-world decarbonisation is key. One could decarbonise a portfolio easily by reducing or eliminating exposure to companies in carbon-intensive sectors such as steel, cement and power generation. A portfolio’s temperature alignment score would look very good in that situation. But we will still need these sectors in 2050, and they need investor capital to be able to innovate, decarbonise and transition – and play a significant role in decarbonising economies. Therefore, we think that investing in companies with ambitious and credible decarbonisation targets rather than divesting has a bigger impact on achieving net zero in the real world.

This is also the core message of the recently launched IIGCC Net Zero Investment Framework (NZIF)⁵, which ASI contributed towards. The framework provides a foundation for how we develop net zero solutions. The core features are detailed below. 

  1. Decarbonising by investing in ‘transition leaders’ – that means not just considering a carbon footprint, but taking a forward-looking view and assessing credible transition strategies.
  2. Allocating capital to climate solutions – that means investing in assets and companies that help the world decarbonise – from renewable infrastructure and low carbon buildings to electric vehicle manufacturers and energy efficient technology providers. 
  3. Net zero stewardship – that means developing a clear net zero engagement strategy with milestones and targets that focus on the most carbon intensive companies in the portfolio.

What are we doing in practice?

We are currently developing frameworks and solutions for clients with net zero ambitions. Phoenix Group, our largest client, set a net zero by 2050 goal for its investment portfolios in December 2020. We are developing net zero solutions across different asset classes to help Phoenix Group meet its goals. For example: 

  1. Our active Equities team is developing an Active Climate Transition (ACT) investment approach based on the foundations of the NZIF. It is focused on identifying and investing in ‘transition leaders’. It does so by bringing together the results of our climate scenario analysis along with our evaluation of company targets and our fundamental research into companies’ decarbonisation potential and strategy. We also focus investment on climate solutions and net zero stewardship as a key lever for influencing decarbonisation. We will provide details of this in a future article.
  2. Our Fixed Income team is using a combination of analyst expertise, our in-house climate scenario analysis data and external data from sources including CDP, the Transition Pathway Initiative (TPI) and MSCI to develop portfolio and benchmark net zero assessment tools. These tools aim to identify those issuers that may be considered potentially ‘Paris aligned’ transition companies, as well as climate solutions providers.
  3. We are assessing what net zero means in Private Markets and are active members of the IIGCC Paris Aligned Investment Initiative working group for Infrastructure and Private Equities. We have committed to work with all of our Real Estate clients to transition their portfolios to Net Zero by 2050.  We have developed a net zero investment framework for Real Estate, which you can access here.
  4. We also incorporate net zero considerations into our Strategic Asset Allocation (SAA) to reflect climate change as another dimension embedded in risk-return optimisations. You can find more on the topic in our award-winning SAA research paper. We will publish a joint article with Phoenix Group on net zero in SAA in April 2021.

How do you assess that your portfolio is on track for net zero 2050?

1. Developing a robust target-setting framework

One of the challenges in net zero investing is to develop robust and meaningful targets and understand the drivers behind any progress made towards these targets. Decarbonisation progress  needs to be tracked against net zero 2050 emissions pathway– that means around 40-50% emission reduction by 2030. The Net Zero Asset Owner Alliance target-setting protocol suggests an emissions reduction target of 16-29% by 2025, either using absolute or intensity carbon metrics – the latter normalises absolute emissions; for example, by dividing emissions by revenue or fund value. Using intensity metrics for decarbonisation targets is useful for comparison purposes, but needs to be interpreted carefully. The carbon intensity metric could fall due to changes in the denominator (e.g. revenue increasing) even if absolute emissions go up. 

It is also important to carefully assess appropriate targets at portfolio, country, sector and firm level. At sector level, mitigation costs and available technologies can differ significantly and this impacts optimal decarbonisation pathways. For example, what is appropriate for power generation where cost competitive renewables can drive decarbonisation would not be appropriate for long-range transportation such as shipping. There is also a geographic dimension to consider as developed market economies ought to be decarbonising more quickly than most emerging market economies, even along a net zero pathway. When it comes to corporate net zero targets, we explore how to assess their credibility in our article ‘Net zero – idle promises?’. 
We are currently developing a net zero target-setting framework that will incorporate these considerations.

2. Take a forward-looking view

The other important aspect is to take a forward-looking view when constructing portfolios. That means not just looking at carbon emissions today, but where we believe company or asset carbon emissions will be in the future based on their transition plans – and whether this matches the desired decarbonisation trajectory. 
To develop this view, we undertake rigorous climate-related research, drawing on sophisticated tools such as our climate scenario analysis framework. This allows us to assess the risks and opportunities related to different climate scenarios (including net zero 2050), understand projected carbon trajectories and the impact of a net zero 2050 scenario on asset values. You can find further details in our recently published climate scenarios white paper here
In our actively managed products we also evaluate companies’ positioning and management teams’ forward-looking decarbonisation strategy and targets, coming to our own proprietary views on how well companies are positioned for transition – particularly for the largest emitters. This is based on active research and engagement, supported by data such as SBT and TPI scores. 

What’s next?

We are excited to be part of the Net Zero Asset Management initiative and will work with our peers and clients to continue to drive best practice around net zero investing. For example, through our continued involvement in the IIGCC Paris Aligned Investment Initiative. We are working on developing net zero solutions across different asset classes focused on real-world impact and will provide more transparency on that in due course.  

We will also explore the topic of investment solutions for net zero at our next Global Climate Action event in June, sharing insights on net zero from different asset classes. You can listen to previous events here.

 

¹ Energy Transitions Commission: Making Mission Possible, Sep 2020

² Energy & Climate Intelligence Unit, accessed 18 March 2021: https://eciu.net/netzerotracker

³ UN Emissions Gap report 2020, accessed 19 March 2021: https://www.unep.org/emissions-gap-report-2020

⁴ UNFCC NDC Synthesis report, Feb 2021, accessed 19 March 2021

⁵ IIGCC Net Zero Investment Framework, March 2021

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Risk Warning

Risk Warning - The value of investments, and the income from them, can go down as well as up and you may get back less than amount invested.