The global economy is off course to hit net-zero emissions by 2050. Efforts need to target financing reduced emissions and real-world impact as this analysis from Ninety One highlights, especially as we mark Earth Day today.
The finance industry’s multi-billion dollar drive to deal with climate change is not working. Real-world emissions are rising, despite net-zero targets pointing in the other direction. In the latest whitepaper by Sustainability Director Daisy Streatfeild, Net zero investing: Searching for returns and real-world change, she argues that if we do not change course, we risk inadvertently doing more harm than good, whilst failing to achieve optimal returns.
Most asset owners have set interim targets either at a top-down portfolio level or for specific asset classes. Planetary Pulse, our global asset owner survey, shows nearly half (49%) of asset owners have an emissions portfolio-reduction target in place1. Some 95% of (NZAOA) members have set emissions reduction targets covering their listed equity and corporate fixed income portfolios2. However, despite practices evolving, it is still unclear if this is delivering the impact intended.
The challenges of reducing portfolio emissions
Since 2015, emissions from listed companies, or those captured in corporate debt indices, have risen 22% according to MSCI Net Zero Tracker3. Divesting assets does not appear to influence the trajectory of high-emitting companies.
Daisy Streatfeild, Sustainability Director, Ninety One: “More than half (53%) of asset owners expect it to get more difficult to achieve emissions reduction targets, while delivering the best possible returns4. A shrinking investment universe that reduces portfolio emissions will exclude industries and sectors that have the potential to transition to low-carbon business models, as well as deliver strong financial returns. In addition, strategies prioritising reduced portfolio emissions are struggling to keep up with traditional benchmarks.”
How can we solve this?
Streatfeild continues: “From an investment perspective, we need to shift focus from reducing financed emissions to financing reduced emissions. This will enable allocation of investment to those who need it the most and allow the finance industry to invest at the scale required for transition and for climate solutions that deliver decarbonisation. Investors also need to engage with high emitters to influence transition plans, recognising that net-zero pathways differ for sectors and regions.”
Portfolio managers need to preserve and safeguard return objectives alongside achieving net-zero goals. This requires focusing on investments that have maximum impact, while managing risk and maintaining diversification across sectors and regions, as well as optimising returns by avoiding restrictions that do not help deliver impact.
Reframing net zero
There are a range of components that investors can consider to reframe their net-zero approach, increasing impact and delivering returns. These include:
- Add dedicated climate solution and transition sleeves, which enable targeted allocations to generate impact through reducing and avoiding emissions, provide diversification and complementary performance profiles.
- Refine net-zero strategies for existing allocations to equities, corporate fixed income and sovereigns to more effectively use engagement and capital allocation to maximise impact, manage risk and maintain return objectives. This includes differentiated approaches for active and passive exposure.
- Adding or enhancing allocations to private markets and real assets given the very significant potential for delivering real economy impact.
- Impact can be further amplified by increasing active allocations, increasing emerging market allocations, and increasing allocations to transition investments and climate solutions.
We have summarised a practical example of adjustments to portfolios and asset class strategies, based on a generic 60% equities, 40% fixed income, in the appendix. The full detailed analysis can be found in the report.
Streatfeild concludes: “The global economy is off course to hit net-zero emissions by 2050. At this stage, our efforts need to target financing reduced emissions and real-world impact. Investors should be looking to increase emerging market allocations, supporting sustainable economic growth and reducing emissions.”
“By focussing on portfolio purity (a reduction of their own portfolio carbon emissions), without delivering real-world carbon reduction, asset owners are not stimulating the kind of change needed to tackle the climate crisis.”
Institutional investors reviewing net zero alignment need to question whether the restrictions in place to limit portfolio emissions and helping or hindering real economy impact. Each allocation within a portfolio can take steps to enhance its contribution to real-world alignment with net zero whether directly through climate solutions and transition investing or through engaging and allocating to align.
