Evolution of the research agenda

While awareness of the investment implications of climate change has increased since the Paris Agreement in 2015, several common issues remain for the investment industry to assist their clients with their net zero aspirations. One of the biggest issues concerns the shortcomings of existing climate benchmarks, many of which focus on backward-looking emissions data that haven’t evolved to reflect the latest climate research. To enable better manager engagement and performance measurement, investors want climate benchmarks to take a more holistic view of the market by using forward-looking indicators (including science-based targets, green capex and patents), and by including regional perspectives and flexible baselines. However, investors also recognise the challenges faced by index providers and therefore often see the creation of better climate benchmarks as a goal to work towards rather than something that can be addressed immediately. 

We acknowledge the challenges that exist when managing dedicated investment portfolios towards addressing the carbon transition. Nevertheless, we aim to address some of these climate benchmark limitations in certain of our own portfolios through integrating insights yielded from our proprietary Carbon Transition Score, which we’ve designed to reach beyond current emissions and science-based targets by assessing companies systematically for transition readiness across more than 15 metrics. In these portfolios, the score may be applied to certain accounts at the company level to help assess progress relative to a sector and/or regional peer group, and to a broad universe to help identify leaders and laggards across an entire market, including through a forward-looking lens.

Finally, the enduring challenge of obtaining Scope 3 emissions data is top of mind, given that Scope 3 data can be a useful indicator of the transition risk that a company could be exposed to. Data availability remains a critical roadblock, with companies in many jurisdictions not required to report Scope 3 emissions, including in the US. Companies themselves also face several challenges when setting Scope 3 targets, as noted in a recent survey (see Exhibit 1) by the Science Based Targets initiative (SBTi). While the introduction of corporate disclosure regimes in some regions, notably the European Union (EU), is a positive step, a lack of harmonisation of Scope 3 data requirements looks set to remain an obstacle for the time being.

The importance of investment stewardship

While portfolio decarbonisation could be easily implemented via the exclusion of high emitting sectors or securities, we noted in our discussions that clients are increasingly focused on the decarbonisation of the real economy instead of simply excluding companies from their portfolios. With this in mind, engagement is increasingly in the spotlight, with clients setting engagement targets alongside their decarbonisation goals. This focus on engagement brings requests for greater transparency from asset managers around their own engagement practices and how these engagements are driving portfolio outcomes. 

Many of the roundtable attendees also recognised the important role that public policy must play in the net zero transition. In this respect, various stakeholders have different levers they can use to address this issue, while certain asset owners might be better equipped to focus on broader public policy engagement efforts than others. The roundtable attendees also stressed the role of company engagement in understanding if the companies they invest in are undertaking lobbying activities that significantly depart from a company’s decarbonisation claims. Because any misalignment may create material reputational and legal risks to such companies, asset managers – as part of managing risk in their client portfolios – use engagement with such companies concerning the transparency of climate-related lobbying activities, or stated policy positions, and the alignment of these activities with such companies’ decarbonisation claims. 

Finally, social factors have a role to play in net zero considerations, with certain clients factoring a just transition into their decarbonisation targets. While social factors can be hard to capture systematically in corporate reporting, we believe engagement to be the best available tool today to help reveal how they are being considered by companies, where relevant, and their potential impact on forward-looking climate-related risk exposures.

Investment opportunities

Beyond the efforts to assess company transition risk and   ascertain credible and meaningful decarbonisation targets for consideration in portfolios with net zero objectives, investors are increasingly optimistic when it comes to the broader investment opportunities that are emerging in response to recent legislation. From policy support, such as the US Inflation Reduction Act and the EU’s Green Deal, to the growing acceptance that investments need to be scaled in areas that can help the world adapt to the negative impacts of climate change, many clients are seeking to increase their allocations to climate solutions.

The potential contribution that alternatives can make to net zero targets is another topic of keen interest, as clients look for assets that can offer both a more direct impact and the potential to generate compelling returns. While data availability and quality has presented a challenge to the use of alternatives, some coalescence around measurement methodologies is now emerging.

Finally, we noted a growing recognition of the opportunities that carbon offsets may provide clients to meet their own net zero targets. However, the timing and the types of offsets to be used remain the subject of discussion. The roundtable attendees see decarbonisation as the primary driver for lowering emissions and therefore want to ensure that offsets are not being used by companies to avoid decarbonising their own operations. Some clients are waiting until 2030 to include offsets in their own targets, as more progress towards decarbonisation should have been achieved by then. 

Conclusion

As the prospects of overshooting Paris climate targets become ever more real, clients are increasingly focused on the importance of reaching net zero. While our series of roundtables revealed many of the obstacles that investors face when setting and executing on net zero targets, we remain optimistic that that we can help our clients to achieve their net zero goals via our deep insights and active investment approach. We look forward to continuing to contribute to the industry dialogue and, ultimately, to helping clients reach their individual goals.