A panel of investors and market practitioners debated last month the implication of a net-zero world on portfolios, discussing the drivers and methodologies behind climate-focused strategies and agreeing that accurately targeting the transition ‘winners’ will be key to returns in coming years.
The panel, part of the Sustainability & Impact Investor Forum in Monaco on October 20 and 21, drew from the perspectives of active fund management across asset classes, asset-owner and indexing specialists. The event took place days before the COP26 climate summit in Glasgow, where nations presented new deadlines to reach carbon neutrality and $130 trillion were pledged by private-sector investors to finance the journey to a low-carbon world.1
The why – the opinion of active investors
The discussion — moderated by George Latham, Managing Partner at WHEB Asset Management — kicked off with an assessment of the key drivers behind the adoption of net-zero investment approaches.
Yvette Babb, Fixed Income Portfolio Manager at William Blair International, said she considers net-zero strategies firstly as a risk-mitigation tool. As a fund manager investing in emerging-markets sovereign debt, Babb said it is vital to manage nations’ risks stemming from physical climate change and adaptation policies whilst being mindful of the development priorities sovereign issuers are pursuing.
David Zahn, Head of European Fixed Income at Franklin Templeton, and Rasmus Bessing, Managing Director at PFA Asset Management, concurred their firms are principally adopting low-carbon strategies because of client demand. Pressure is also increasingly coming from regulators, Zahn added.
“It’s an obligation for us to ensure not just returns for our beneficiaries but that the world they retire in is one worth living in,” said PFA’s Bessing, whose company is a major pension fund manager in Denmark, as well as a life and health insurer.
For Neil Brown, Head of Equities at GIB Asset Management, sustainability is about investment performance as much as it is about generating a positive environmental impact.
“Getting to net zero in a fair and just way is one of the greatest challenges we face; and therefore, it will bring some of the world’s greatest profits,” Brown said. “The money will come from those who win the race to net zero, but the world in which we live will depend on the laggards and taking those along.”
The how – the active perspective
Next, Latham asked the group how investors are pursuing net-zero strategies.
Here, Franklin Templeton’s Zahn and PFA’s Bessing coincided again. As active investors, both highlighted the leverage that company engagement brings to power transformation and to ensure that companies fulfill their carbon commitments. Rasmus said that PFA, as an asset owner, has a steward responsibility to generate change within investee companies.
With a fast-growing number of net-zero group initiatives and more companies signing up to them every day, investors have an opportunity to assess those commitments and engage with companies as stakeholders to make them accountable.
“We want to maintain positions but companies that have said they will get to net zero need to prove they’re getting there,” Zahn said. “We don’t want to exclude the most polluting ones and make the portfolio look clean. The most money will be made from dirty industries that figure out how to change quickly. So that’s where engagement comes in.”
“We’re very engaged with companies we’re invested in,” Bessing said. “We set measurable targets for different sectors and try to encourage them on a journey.”
An alternative and popular approach to net-zero investing has grown around index-based strategies, thanks to advanced ESG data and increasingly smarter technology tools. ETFs with a climate objective grew their net new assets by 330% globally in 2020 to $72 billion, the fastest-growing theme within the broader ESG category.2
Anna Georgieva, Senior Sustainable Investment Specialist at Qontigo, said that the momentum for climate strategies in the passive space has never been greater. Yet, to drive change further, she said investors must assess the real-world impact of their portfolios and differentiate between low-carbon strategies relative to benchmarks, and true, net-zero approaches that are based on scientific decarbonization paths.
Georgieva explained the role of an index provider like Qontigo in offering sophisticated indexing solutions to scale clients’ impact, and to enable them to express their own view and utilize customized datasets.
“Our indexing approach is based on an open architecture design that allows us to access best-of-breed ESG data from third-party providers for different use cases, while also flexibly onboarding client data,” she told the audience. “And the second differentiator is portfolio optimization — which allows us to deliver targeted exposure to risk, return and impact.”
Investors can resort to off-the-shelf index solutions, such as the STOXX Paris-Aligned Benchmarks (PABs), retro-engineered to reach net zero by 2050: with an initial 60% decrease in carbon intensity and a 7% year-on-year decrease going forward. One of these indices underlies a pioneer fund complying with the European Union’s Climate benchmarks regulation, and managed by Amundi.
“Because there is a consensus that engagement is among the most powerful ways for investors to achieve impact in listed markets, Amundi is actively engaging with constituent companies of this passive product to encourage climate target setting,” Georgieva said.
Alternatively, indices can be tailored to allow clients to best express their own views and use proprietary datasets. The STOXX Willis Towers Watson Climate Transition Indices (CTIs), for example, were introduced last October following a collaboration between Willis Towers Watson and Qontigo. The indices employ WTW’s unique Climate Transition Value at Risk (CTVaR) methodology that quantifies the anticipated impact of a decarbonization transition on equity valuations, enabling investors to address climate-related risks and opportunities with a forward-looking lens that doesn’t rely on the traditional carbon footprint focus.
The panel concluded that net zero is a true challenge of our times for companies, nations and the asset-management industry. All participants agreed that everyone’s focus will be on how governments, regulators and public opinion evolve their view on the decarbonization targets that will get only more pressing after COP26.
Climate action to become even more crucial
Other meetings at the Sustainability & Impact Investor Forum, organized by IM|Power, discussed changing allocations between sustainable, impact and thematic funds; the shift from integration to solution-based approaches to ESG; and Europe’s Sustainable Finance Disclosure Regulation (SFDR) as a tool for competitive edge. All debates brought an enlightening exchange of ideas at a time when climate action has become a key consideration for the world’s largest pools of capital.
1 Bloomberg, ‘Carney Unveils $130 Trillion in Climate Finance Commitments,’ November 2, 2021.
2 Source: Qontigo Market Intelligence.