NAVIGATING A PATH TO NET ZERO - PRACTICAL CONSIDERATIONS FOR MEETING YOUR CLIENT COMMITMENTS

Key Takeaways:

1. There are three key categories of tools available to help reach net zero; aligning investment to environmental solutions or through offsets; engaging within the investment chain, with policy makers and through collaboration; and exclusion of carbon intensive investments that are not able or willing to transform.
2. Progress is starting to be seen in some areas, for example carbon intensity in certain indices is falling.
3. Engagement with multiple stakeholders that emphasises transparency is key to achieving short- and longer-term change.
4. Collaboration is very important for smaller players to maximise their potential influence through common aims. 

Context: 

While there is increasing acceptance of the need to act to transform portfolios with a view to net zero, there is demand for more detail on how much is being done in practical terms and where should the focus of efforts be. This includes exploring what it means for portfolio construction, for engagement with managers, for strategy selection and how to actually align portfolios while accounting for client needs. 

Takeaways:

1. There is rising awareness amongst the public and in investment about the necessity to act on climate and work to achieve decarbonisation. The question is whether this awareness translates into action or is the focus still on simply maximising returns?

According to a survey run quarterly by the Department for business Energy and Industrial Strategy, 76% of the general public were aware of the term net zero in December 2020 (this fell to 62% in March 2021). What is less clear is whether understanding of the concept translates, even though there is high concern amongst the public about climate change.

Investors are increasingly seeing the same charts that show how the economy needs to adjust to aiming for a “1.5 degree” path, in alignment with the Paris Agreement. But it may not be clear what the combination of action is required to ensure that you ultimately target what you invest into areas that can positively contribute to a more sustainable economy. It requires an understanding of how the landscape is developing as well as understanding how to invest in assets that are able to decarbonise over the appropriate time frame to hit targets; the carbon intensity of the MSCI index on a global basis has fallen by more than 15% over the last two years - as an indication that things are starting to progress. Index providers are an area where there is little direct engagement at present but this is likely to be a developing area in the future.

2. The client perspective

Talking to clients about what they are trying to achieve to understand their beliefs and how this translates into action in their portfolio is key. This could be setting objectives including on carbon intensity, or having ESG aligned solutions. It also means selecting managers that are appropriate to execute actions to meet their objectives. 

Of course, it can be difficult to navigate the wide range of opinions that may be held across a client base in addition to the range of assets. An option here can be to provide portfolio-level solutions that are aligned with recognised benchmarks. Some clients will also need to be provided with information on risks and opportunities relating to climate issues and their portfolios. There are resources to support this, for example the Prudential Regulation Authority’s climate stress tests. 

3. All forms of engagement

Engagement is a key aspect in setting expectations and recognising change over time. Engagement is also the conversations with more than just investee companies, it covers conversations along the investment chain and with related stakeholders. This means, as noted, identifying client beliefs and needs, to be able to understand both how to construct portfolios or products that will deliver to a set of identified objectives.

It also engagement with the asset managers that have been selected because they meet the right criteria for successful execution of client needs. This applies within their organisations (how they run their teams, conduct research and are expert in the subject matter) as well as how they engage with companies, they are investing in.

This is often an incremental process over time, communicating with managers that the direction of travel is towards Paris alignment, but it could be small steps that take you there. Investors should promote transparency during conversations in order to identify the most important targets for engagement but also to deploy resources where they are most effective. The focus can be on the those with the most improvement potential, including due to a productive relationship. It’s helpful to look at the tools that are developing in the reporting space, to aid disclosure including the Taskforce on Climate Related Financial Disclosure’s framework.

Engagement also occurs with policy makers, and with - and within- industry action groups. It’s important to leave space for engagement to create outcomes over time, but it is also necessary for there to be evidence to support any impacts and outcomes that are being claimed to be occurring. Firms should be setting these expectations with managers on what evidence they need to see.

When engagement paths have been exhausted exclusion is available as an option. Although some firms will take an exclusion approach at the outset when determining their universe, if they are invested, engagement can be a powerful tool to push for changes. The recent cases of shareholder action in the extractives sector (the change in board members at Exxon and court case in the Netherlands ordering Shell to cut emissions, subject to appeal) are good examples.

They also demonstrate the importance of collaborative groups with the same aims, including membership organisations, specific issue collaborations and industry bodies. In particular, these can be vital for smaller firms to ask questions, request more information and set expectations and standards with larger asset managers.